Weathering The Storm

The levees in New Orleans held. The Republican convention is underway, and “drill, drill, drill…” is Larry Kudlow’s partisan answer to all that ails this domestic economy. All the while, the emotionally removed and analytically objective are surveying the world’s proverbial storms.

I have maintained for some time now that the largest market flood gate that has yet to open is that of the hedge fund industry. This has not been a popular call amongst my industry peers, but it has been the right one to stay with. As Bloomberg all-star Kathy Burton (author of Hedge Hunter’s) pointed out yesterday, “"Sixty-one percent of the 2,795 funds managing more than $100 million that are in New York-based's database are losing money in 2008."

Bubbles popping are processes, not points. As the facts get louder, revisionist historians are issued more impactful ones. This morning, that high profile fact is that commodity levered long hedge fund, Ospraie, is being forced to liquidate. Being from Thunder Bay, Ontario, has its analytical advantages. One of the local facts is that it has harbored the most contiguous grain elevators for one port in the world. At the peak of the commodity bubble, Ospraie was buying grain elevators! No, unfortunately I cannot make this stuff up.

My grandfather, Russ, proudly worked in Thunder Bay’s harbor for Provincial Papers as a Stationary Engineer for over 40 years, and was a member of IUDE # 865 Boiler Makers Union. He was not a hedge fund man, but I can tell you this, if he heard of this hedge fund “Trade” for elevators, he would have snickered, and asked “how many beers did the buyer have?!?”

From Goldman’s prop desk to lesser known hedge funds, the commodity bubble popping will reverberate deep into the moorings of the US Financial system. Commodities are what they are by definition – commodities! Putting leverage on top of commodity leverage is what Dick Fuld did when he had Lehman take a 20% stake in Ospraie in 2005. Fuld clearly didn’t “do macro”, so how can you blame him for Ospraie being down -27% in August. At least he can’t blame and fire his former CFO, Erin Callan, again – she’s left the Lehman building and now oversees hedge fund strategies at Credit Suisse First Boston. Nope, I can’t make that up either.

As global growth slows, the levered bet on global commodities pops. As commodity levered hedge funds liquidate, the commodity “prop desks” at US investment banks have to de-lever. As the world de-levers, the velocity of capital markets screeches to a halt. Asian growth slows, their currencies break down, and all that “Sovereign” cash begins to de-flate.

Incidentally, that’s my answer as to why the US market had a nasty intraday reversal yesterday…

All the while, the men running Citigroup, Lehman, and the US Treasury, are the ones who oversaw and oversee these global proverbial storms. Pandit at Citi blew up a hedge fund; Fuld’s news is on the tape; and Paulson’s Goldman Sachs is getting banged up all of a sudden. Maybe we should get these three “leaders” of what used to be American Capitalism some of them CNN red hurricane jackets and put them out in the “field” to report on this situation live. Maybe we shouldn’t… that would really be embarrassing.

The world economy is as interconnected as it has ever been. This storm is real, and “global this time”, indeed.

Good luck out there weathering it,


If you’ve been following Atlantic City for awhile I’m sure you’ve heard the “under roomed” description tossed around quite a bit by managements and analysts alike. Similar to Las Vegas’s investor tag line, “new supply drives visitation”, the description is starting to ring hollow. Harrah’s Atlantic City opened its new 961 room Waterfront Tower in May and Borgata (50/50 JV between BYD and MGM) followed with 800 rooms at The Water Club in early June. Market implications were not positive in terms of RevPAR or gaming revenue.
  • As can be seen in the first chart, Atlantic City market RevPAR fell 6% in Q2. Harrah’s and Borgata fared even worse, suffering cannibalization to the tune of down 7% and 16%, respectively. Q3 looks even worse considering both towers opened after the 2nd quarter mid-point. On the gaming side, the market gained nothing from almost 1,800 new rooms. Contrary to the commonly held wisdom that new rooms bring new visitors, market gaming revenue fell 7%. I understand that AC continues to battle new competition from Pennsylvania, but the June/July decline was more severe than the YTD drop.
  • If Borgata is benefiting from the new tower, it is hard to see it in the numbers. The huge RevPAR decline and flattish June/July gaming revenues do not bode well for an acceptable ROI, despite the quality of the facility. On the other hand, Harrah’s posted a solid 20% gain in July gaming revenues following only a 5% June increase. For its 4 properties combined, however, gaming revenue actually fell 1%, once again bringing cannibalization into consideration. The guys at TRMP have to be sweating a bit following this weekend’s opening of their 782 room Chairman Tower.
Market and properties not absorbing new rooms
No market gaming revenue growth from new towers

Positive data point for QSR Pizza Operators

We just got the July NPD numbers and the QSR pizza category traffic trends improved sequentially to down only 0.6% from June’s 2.5% decline and 2Q08’s 1.7% decline. DPZ is facing easier same-store sales comparisons in 2H08 of 0.8% and -1.1% from 3Q07 and 4Q07, respectively, relative to the 4.4% number the company just lapped in 2Q08. This sequentially better number does not even account for the Olympics, which should also drive incrementally stronger results for the QSR pizza category in 3Q08.

DPZ’s CEO, David Brandon, stated on its last earnings call, “As it relates to the Olympics, any time people are sitting in front of a television set, glued to things that are happening, that's good for our business. It's good for pizza delivery and it's good for Domino's. So as it relates to the Olympics, without going any further in terms of any of our plans and programs during that timeframe, I can tell you we're looking forward to it because usually that's a great opportunity for us.”

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Charting Fokuda: Stay Short Japan (EWJ)

Below we have charted the Nikkei vs. Fokuda's unsuccessful 11 months attempts as Japan's PM.

Andrew Barber

China's Tanking Purchasing Managers Index (2004-2008)

We've updated this chart for this week's data. China's PMI has moved to a contraction zone. This is ominous, but to some extent discounted by a stock market that's down -62% since it's October 2007 peak.

Keith McCullough & Andrew Barber
Research Edge, LLC

India's New Central Banking Headache

Here’s a chart illustrating what Subbarao inherits as incoming central bank governor of India. Yesterday the ministry of commerce came out with trade balance numbers –the trade deficit continues to be driven by rising global commodity prices. Subbarao now must raise rates aggressively and increase debt in order to curb inflation and also pay for the administrations populist voter kickbacks (Bloomberg reports that Singh approved a 21% pay raise for civil servants and a $17B farm loan forgiveness package recently).

BTW: Subbarao was a Humphrey Fellow at MIT. The Humphrey Fellowship is a US state dept. funded program for foreign students of economics. The fellowship is named for Hubert Humphrey, the Vice President during the Johnson administration who helped to craft the “great society” platform of heavy government spending on social programs intended to eliminate poverty that resulted in inflation and increased debt (which, combined with the unpopular Vietnam war, cost Humphrey the presidency when he ran against Nixon in 68).

Andrew Barber

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