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Capitalist Survivor

"The human body can take damn near anything. It's the mind that needs training." - Instructor Reno
For those who took Keith's book recommendation on May 26th, you'll know that quote above is from a drill instructor depicted in The Lone Survivor, Marcus Luttrell's first person account of the 2005 SEAL operation in Afghanistan that resulted in the greatest-ever single-day loss of life in the elite unit's history.  
Instructor Reno says this during the infamous SEAL 'Hell Week,' which puts the candidates through unthinkable mental and physical stress with the purpose of eliminating all but the toughest warriors on the planet. The part of this quote that I can't (and don't want to) shake is that towards the end of Hell Week, if someone expressed the desire to quit, the drill instructors would offer them a second chance before they officially 'rang the bell'. A seemingly kind gesture, but one offered with indifference. Why?
No one who takes the offer actually ends up finishing the program - ever.  Once the thought of quitting manifests itself into action, it's pretty much 'game over.' It's like trying to uncrack an egg. Those that complete the program and join the esteemed ranks of the Navy SEALs were truly in control of their own destiny - mentally and physically -- throughout the entire torturous initiation.
I know... you're probably thinking "Thanks McGough, but I'd love to see how you're going to actually tie all that in to an investable theme." That theme is something that you've seen Keith write about time and time again - proactively building and managing a process that allows you to always be on offense, and in control of your destiny.
Trust me; I'd love nothing more than to tie-in the armed forces theme with bullish comments about US markets as Independence Day draws near. But I cannot.
The real survivor in this interconnected Macro web is China. China is in control of its own destiny, and if it ever feels the desire to 'ring the bell,' it certainly does a great job of hiding that from outside observers like me.  China is always on offense - always in control - always a capitalist.
Check out the third most read story on Bloomberg this morning. "China Allows Yuan Trade Settlement, Offers Tax Breaks To Shift From Dollar."  China's official statement includes the following verbiage...
"Companies in China and neighboring countries are facing relatively huge risks of exchange-rate fluctuations because of big swings in the U.S. dollar, the euro and other major settlement currencies during the global financial crisis."
Need I say more? Probably not. But I will anyway...
Let's also take this to the industry level -- Apparel/Footwear Retail for example (86% of our footwear comes from China alone).
There's a lot that controls the margin inputs for any company. For a company tied to this supply chain, one of the majors is the FOB cost of the goods. In plain English, this is Freight On Board, and represents the all-in cost to land a product on US shores. From 2000 through 2007, this cost came down precipitously as capacity in China grew to fulfill a change in WTO regulations that allowed it to scale up production. The timing and magnitude of this change allowed so many US players to garner more margin dollars than they deserved.
But then China changed its offense. In 1Q07, with the Olympics looming, China cracked down on sweat shops, mandated back-pay for factory owners to employees for unused vacation time, and pulled the ultimate lever to reduce capacity - it lowered the VAT rebate. The VAT (value added tax) stands at about 17% in this category, and the government rebates a given portion of it to encourage exports vs. local consumption. In early-'07 this rebate stood at about 13%, and subsequently came down into the single digits.  Think about it...if you are a factory with a profit margin of 3% (about average over the past 10 years) and then not only do your labor costs go up, but your VAT rebate goes down by 500bps, that turns into a pretty catastrophic event. The result? In '07 and '08 the factory count in China's Pearl River Delta went from about 12,000 down to about 6,000. No joke...
The trajectory of exports fell like a stone - bottoming at -23% in 1Q. So how did China react? Yes, the VAT rebate is headed up again - and now is at 15% (above '07 peak). Other countries such as India, Malaysia, Indonesia, Pakistan, and others have followed suit. We've seen around 1,500 factories reopen in China, and there's more to come.

Capitalist Survivor - image001

How's that for proactively managing growth? Most US retailers don't even have a clue as to this dynamic. I'd argue that we're entering a period where they earn what China wants them to earn.
The bottom line is that the companies that really 'get' China are the real survivors. That's the long-term call. There are the ones that have been investing there over the past 10 years. Not those that started last week because the manic media said that they have to.
Have a terrific long weekend with your loved ones, and thanks to all those courageous men and women who are unable to do so as they fight to protect the freedom of this wonderful country.
Brian McGough

EWZ - iShares Brazil-President Lula da Silva is the most economically effective of the populist Latin American leaders; on his watch policy makers have kept inflation at bay with a high rate policy and serviced debt -leading to an investment grade credit rating. Brazil has managed its interest rate to promote stimulus. Brazil is a major producer of commodities. We believe the country's profile matches up well with our re-flation theme.

QQQQ - PowerShares NASDAQ 100 - We bought Qs on 6/10 to be long the US market. The index includes companies with better balance sheets that don't need as much financial leverage.

EWC - iShares Canada - We want to own what THE client (China) needs, namely commodities, as China builds out its infrastructure. Canada will benefit from commodity reflation, especially as the USD breaks down. We're net positive Harper's leadership, which diverges from Canada's large government recent history, and believe next year's Olympics in resource rich British Columbia should provide a positive catalyst for investors to get long the country.   

XLE - SPDR Energy - We think Energy works higher if the Buck breaks down.  

CAF - Morgan Stanley China Fund - A closed-end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the wave of returning confidence among domestic Chinese investors fed by the stimulus package. To date the Chinese have shown leadership and a proactive response to the global recession, and now their number one priority is to offset contracting external demand with domestic growth.

TIP- iShares TIPS - The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield on TTM basis of 5.89%. We believe that future inflation expectations are currently mispriced and that TIPS are a compelling way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

XLV- SPDR Healthcare - We re-initiated our long position in healthcare on 6/29. Our healthcare sector head, Tom Tobin, wants to fade the public plan, and he's been right on this one all year.

GLD - SPDR Gold - Buying back the GLD that we sold higher earlier in June on 6/30. In an equity market that is losing its bullish momentum, we expect the masses to rotate back to Gold.  We also think the glittery metal will benefit in the intermediate term as inflation concerns accelerate into Q4.


EWI - iShares Italy - Italian Prime Minister Silvio Berlusconi has made headlines for his private escapades, and not for his leadership in turning around the struggling economy. Like its European peers, Italian unemployment is on the rise and despite improved confidence indices, industrial production is depressed and there are faint signs at best that the consumer is spending. From a quantitative set-up, the Italian ETF holds a substantial amount of Financials (43.10%), leverage we don't want to be long of.

XLY - SPDR Consumer Discretionary - We shorted XLY on 6/19 as our team has turned negative on consumer in the last week.  

XLP - SPDR Consumer Staples - We shorted XLP on the bounce on 6/17.   Added to the position on 7/1, as our stance on the consumer is no longer bullish like it was in Q2, when gas prices and mortgage rates were dramatically lower.

SHY - iShares 1-3 Year Treasury Bonds - If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic



According to Lusa, Macau casinos recorded revenues of 8.25 billion patacas in revenue during June, down 17% over the same period last year and 6.3% lower than the month of May.  The first half of 2009 was down 12.4% year-over-year, with 51.4 billion patacas in revenue compared to 58.7 billion patacas in the first half of last year. 

SJM maintained the top spot in terms of marketshare, with 30% of the revenues in June, followed by LVS (26%), Wynn (14%), Galaxy (12%), Crown (9%), and MGM (8%).  


Despite calls for liberalization of the sector, Stanley Ho's Macau Slot remains the sole operator of over-the-counter and internet soccer and basketball betting in Macau.  The administration of outgoing chief executive Edmund Ho Hau-wah has extended the monopoly by one year. 

Rival casino operators and foreign sports-betting firms have expressed interest in launching and managing betting operations in Macau, should the monopoly be broken.  Macau Slot struggles to compete with the larger sports-betting market in Hong Kong.  Whether or not there will be liberalization of the sector will be determined by the incoming chief executive.  Macau Slot is 48% owned by SJM Holdings. 

Bear Mauling Continued: SP500 Levels, Refreshed...


Here's our updated quantitative views as of 3PM pricing:

The immediate term TRADE breakout line for the SP500 is at 923. A close above that gets me 939. With the prior YTD closing high being the dummy target up at 946, there is no reason why we can't see that 939 print sometime tomorrow morning (remember, I think that employment report is going to be a sequential improvement, so I have a catalyst).

This morning's Bullish to Bearish sentiment survey showed some compression in the spread between bulls and bears. That, on balance, is a bullish indicator. Be rest assured that there are still plenty of Depressionista bears out there getting mauled. Stay long short interest.


Keith R. McCullough
Chief Executive Officer


Bear Mauling Continued: SP500 Levels, Refreshed...  - a1

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.51%
  • SHORT SIGNALS 78.32%

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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