Dr. Copper Seeing Inventory Declines


Portfolio position: Long Southern Copper, ticker PCU

The LME (London Metal Exchange) reported copper stock levels earlier this week, which highlight declining inventories in London, a trend that has been intact since early March.  As of June 29th, stockpiles monitored by the LME had fallen for 37 straight sessions.  This was on the back of Shanghai Futures Exchange showing copper inventories tumbling by 18% week-over-week, which was its first drop since May.

Interestingly, while inventories on the LME have been consistently falling, inventories in the U.S., as reflected by CME stores have been consistently rising over the same time period.  The CME is smaller in scale than the LME, and this data from the CME, which reflects copper demand in the U.S., likely suggests that the economic recovery is taking a little longer to take hold versus the world, namely China.

There has been speculation that China was amassing copper for speculative purposes and that the copper wasn't being used in actual infrastructure build.  Evidence from China on June 29th appears to suggest that isn't the case.  According to reports, Yu Dongming, who is an official at the metallurgical department of China's top economic planning body, confirmed the State Reserves Bureau had amassed a lower-than-expected, 235,000 tonnes of copper.  The implication is that if the government has a lower than expected store, then copper imports are in fact being used in infrastructure building.

As we wrote on May 21st:

"We have an expression (to be fair, we have many expressions) at Research Edge and we say, "She / He has the Conch", which effectively means that whomever has the conch has the voice or the floor to continue to own the debate.  When it comes to copper, China has the Conch.  In fact, in the year-to-date the correlation between the Chinese stock market and copper is 0.88."

This correlation that we called out six weeks continues to hold and while both the Chinese stock market and price of copper are up meaningfully from May 21st, the fundamental case has only improved with declining inventory data from around the globe.

We are positioned long copper via a position in Southern Copper, PCU, the copper company that is majority owned by Grupo Mexcio SAB.  PCU has copper assets primarily located in Peru, Mexico, and Chile, which are relatively low cost group of assets.  PCU also boasts a pristine balance sheet with ~$600MM in net debt versus a market capitalization of ~$17.8BN, and TTM EBITDA of ~$1.8BN. 

In effect, PCU very directly represents our TAIL theme of being long those companies with meaningful economic leverage, and limited financial leverage.

Daryl G. Jones

Managing Director

 Dr. Copper Seeing Inventory Declines - a1


Chart of The Day: Burning The Buck...


To kick off Q3, the US Dollar was already weak... post the open we've had a few dampeners hit the tape that have exacerbated today's US Dollar weakness:

  1. China asked to discuss a "new global reserve currency" at the G8 (in Italy)
  2. Fed President Evans (Chicago) made a comment about the Fed's discussion about an "exit strategy" not involving a timeline

On the first point, we've been saying this all week and I'll say it again - the Chinese are selling US Treasuries, period. They aren't going to give the USA a real time memo while they are doing it either. Chinese Central Bank Chief Zhou's comments earlier in the week were misinterpreted by the manic media. He said there would be "no sudden change" to policy. No rational investor signals to the world that they are acting "suddenly" with their largest position. To be clear, the Chinese have stopped buying US Treasuries and are selling, gradually - not "suddenly".

On the second point, the Fed's credibility on inflation forecasting is negative. They missed the meltup in 2008 commodity inflation, and now they're hoping they don't see its birth as a result of the most politicized credit creation in the history of America. Hope is not a long term investment process. See my note earlier today titled "Reflation morphing into inflation" for the most current data point we have US Dollar based prices paid.

Finally, and most importantly, there's the marked-to-market price reality of the US Dollar (charted below). The red line with fuses burning is our government Burning The Buck. Long term TAIL resistance is now at $82.26 on the US Dollar Index, and as the USD trades below that line, we're going to be importing real inflation starting in Q4.

If you want a solution to this currency crisis, raise rates from these ridiculously low "emergency" rates that are currently compromising America's credibility.



Keith R. McCullough
Chief Executive Officer

Chart of The Day: Burning The Buck...  - a1

India: Great For Investment Bankers!


India's equity market rebounded last night to make up over half of Tuesday's Sensex decline as the market continues to digest a slew of secondary offering announcements. In addition to corporate announcements, moves by the Oil Ministry to reduce retail fuel subsidies is seen by some as a government move to help refiner margins in advance of government divestitures in the energy sector.

For BSE listed firms, the massive run up in recent months provides an irresistible liquidity opportunity -particularly as spreads for corporate borrowing have remained stubbornly high despite loosening RBI policies.  How big an impact dilution can have on the equity market is a matter of debate, but with total BSE market capitalization roughly equal to the combined capitalization of Exxon and PetroChina and with major hurdles still facing foreign direct investment into the equity markets any share sale overhang will likely elicit a sharp response in the near term.  

Trade Data:

Trade data released by the ministry of commerce overnight continues to paint grim picture for external demand. Exports declined for the eight consecutive month on a year-over-year basis registering at -29.2%, a sequential improvement over last month's record decline (see chart below).  Declining imports drove the trade deficit to expand for the month to $5.2 Billion.

 India: Great For Investment Bankers! - INDIA exports

A lot of readers continue to ask us about our perceived negative bias to Indian equities , in spite of (or perhaps inspired by) the 50% YTD Sensex run.  If we were outright negative, we'd be short the IFN - we're not.  For the most part we agree with the bulls on the positive implications of the election results, but duration is critical in any discussion of our view on India. Strategically (that is, on a longer duration) we have a negative bias towards the Indian economy on a relative basis, and yesterday's export data cuts right to the heart of one of the key factors in our thesis.

Many strategists believe that India's relatively modest dependence on exports, at just 15% of GDP, is helping to contribute to a "virtuous cycle" of internally driven development.  We are not convinced. By largely "skipping" the industrial phase of development and moving directly towards a service and technology based economic base, we think that there is a major risk is that the 55% of the population that are rural farmers living in dire poverty will be unable to close the wage and education gap to become developed world level consumers. Educational and economic programs designed to eradicate poverty implemented by the government have thus far been profoundly unsuccessful in closing this gap. 

Ultimately, if the majority of the Indian population are unable to develop into domestic consumers for the growth industries that are the cornerstone of the rapid economic growth in recent years, we are confident that the economy there will grow at a slower rate than developing nations that have faster developing consumer bases.

One of the easy traps that we see our fellow investors falling into with respect to India is the "law of big numbers" -the notion that India has such a huge population that there has to be tremendous growth in the long run. We partially reject this notion and believe that the current course of Indian development -while increasing the size of the middle class in both size and relative affluence, will not elevate the vast majority to the same consumption growth level that we anticipate that Brazilian and Chinese populations will.

In short we see India's much vaunted lack of export dependency as a critical long term weakness rather than strength -and that puts us at odds with many other observers.

Having said all that, in the near term we actually agree with many of the most vocal bulls on India with respect to opportunities for individual companies and brands, and furthermore see the Singh administration's victory as a catalyst for new efficiency in development process overall.  We simply diverge from the hyper-bulls over the size of the macro hurdles which the Indian economy faces, and believe that there are many developing markets which present a more attractive long term growth opportunity.

Far from being contrarians, we are committed developing market investors, who just happen to see many economies that present more attractive long term opportunities than India.

For big banks and brokerages, the watershed moment of the Congress Party's victory opened the door for a wave of secondary offerings, government divestitures and IPOs that will no doubt generate a huge amount of fees. Perhaps if Research Edge had a syndicate desk I would be as bullish as my competitors.

Andrew Barber

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MCD - Angus Rollout Is Sooner Than Expected

Bloomberg reported that MCD will be rolling out its new premium Angus burgers nationwide tomorrow, which is one month earlier than rumored. The company had previously stated that the rollout would come in 2010. The new line of burgers will be priced at about $4 relative to its Big Macs and Quarter Pounders at about $3 and its ever popular Dollar Menu. Going premium has not worked for MCD's competitors in this current environment, particularly CKR and BKC.

This premium priced offering may have made some sense about two years ago when MCD began developing the Angus burger in response to a request from franchisees in southern California for a product to compete with Carl's Jr.'s more premium products. Since then, Carl's Jr.'s same-store sales have slowed significantly and even turned negative in the last two quarters, which points to the difficulty of trying to sell premium priced products in today's environment. Consumers do not want to spend a lot of money when they go into a fast food restaurant. So, the obvious question is why now?

MCD knows how to launch a new product and this new Angus burger will inevitably receive a lot of attention within QSR and spur a lot of trial. MCD management knows this so there is some speculation that the company is rolling out its premium burger now, despite the economy, to offset sales weakness. For reference, I am sure it is no coincidence that the rollout was scheduled for July seeing that the company is lapping a 6.7% U.S. comparable sales number in July. It has long been my belief that MCD's premium coffee strategy will not provide the sales catalyst investors are expecting and the timing of this premium burger rollout only strengthens my argument that the early read on MCD's coffee strategy is not good.

To be clear, the Angus burger will provide a lift to MCD's numbers in the near-term as the company will be heavily promoting its introduction. And, as I said once before, it could also help the company's coffee sales as I would not be surprised to see a coupon for a free latte with the purchase of an Angus burger to boost McCafe sales or vice versa! This nationwide launch is a definite negative for CKR and Carl's Jr. The concept's premium menu focus was already hurting traffic, which has been negative for the better part of the last two years. MCD's presence in the premium segment of QSR will only increase CKR's pain.

MCD - Angus Rollout Is Sooner Than Expected - MCD US May SSS

Reflation morphing into Inflation...

Notwithstanding The New Reality that this morning's ISM report (June) was another sequential acceleration and the best print since August of 2008 (yes, before the narrative fallacy of the Great Depression that forced the politicized Fed to cut to "emergency" level interest rates), the prices paid component is turning into a moon-shot.

Prices paid - those are leading indicators for reported inflation and, of course, they are paid for in US Dollars (which are getting smoked). The rest of this picture is self explanatory - see the chart below and, remember, what matters most to our macro model is what happens on the margin.

The Bond market gets this. The Fed isn't allowed to, yet...


Keith R. McCullough
Chief Executive Officer

Reflation morphing into Inflation...  - a1

Sales Relief to Close out 2Q?

The across-the-board snapback in sports apparel sales for the week endiing 6/28 is just what the Dr ordered, and starts off 3Q with a ray of hope.


Sales Relief to Close out 2Q? - Table


Sales Relief to Close out 2Q? - Sports Apparel   chart


Sales Relief to Close out 2Q? - ASP sports apparel chart

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