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Takeaway: The latest CPI number confirms what we've been saying about inflation accelerating.
The quantitative set-up for Brent Crude is in what we call a Bullish Formation (i.e. bullish on all 3 of our core risk management durations, TRADE, TREND, and TAIL).
Brent Crude increased +4.4% on ICE last week to its highest level since September and now sits at +1.8% YTD after hovering unchanged for most of the year. WTI also touched 9-month highs on NYMEX on Friday, closing at +4.1% on the week (+8.6% YTD). Market sentiment, as measured by net positions in all actively traded futures and options contracts, suggests the market is leaning 4.7% longer than its 6-month average. Volume in Brent has spiked and front-month implied volatility has more than doubled to 18% from the lowest levels since 1988 on June 3rd (7.2%).
The CRB sits at +10.5% YTD with 16 out of 19 commodities in green territory. We reiterated our consumer slowing call yesterday in the chart-of-the-day by showing a snapshot of just how sensitive the average American is to food and housing prices:
Hedgeye’s inflation call has not been to ignore the potential price impact of unexpected weather and geopolitical tension in commodity markets year-to-date. Periods of relative calmness followed by bouts of heightened volatility have historically been commonplace. The commodity inflation that perpetuates our #consumerslowing theme remains a self-reinforcing headwind on the consumer. With a final Q1 GDP revision that could be as low as -2% on the 25th coupled with a CPI reading this morning that doubled-up expectations (+0.2% vs. +0.4% estimated), an easier than expected policy response tomorrow from Janet Yellen is probable.
Market participants choose to hold commodities for different reasons. For example, our view on Gold’s interaction with policy has been well documented. We added Gold (ETF: GLD) to Hedgeye’s investing ideas on May 23rd and remain comfortable on the long-side:
To clarify our process, we do not view the choice to hold GOLD or something like a COFFEE futures contract to hedge the heightened expectation of future dollar devaluation as interchangeable. With regard to the push-back we have received on highlighting weather-driven, overextended softs and agricultural commodities as a driver in our inflation call...
We have not made the argument that the entire complex’s negative correlation with the dollar is purely a growth and policy relationship. However, a spike in the cost of the goods and services that people consume alongside a flat dollar perpetuated by wealth-destroying monetarism burdens the consumer on the margins. This squeeze results in slower-than-expected consumption growth. We highlight the risk in this environment by alluding to sector variances and the increasingly negative correlations between the U.S. dollar and the commodity complex as a whole as this shift takes place.
Therefore, ignoring all arguments for why commodity prices are at artificially-high levels (i.e. weather, geopolitics, etc.), the reality is that they ARE in fact much higher from three months ago:
It will always be difficult to predict the next volatility-producing event in the space, but consequential responses to sharp changes in supply and demand are almost certain to follow. Unfortunately monetary policy has made the average consumer increasingly sensitive to commodity and asset price inflation as margins become thinner on a micro level. Almost 50% of the average American’s after-tax income is spent on food, housing, and utilities.
Proven crude oil reserves seem plentiful with North America’s newly utilized capacity. Brent has hovered in negative territory for most of the year with the crack spread near all-time highs despite geopolitical tension and a surge in the commodity complex. The forward curve suggests this downward trend will continue:
However, a number of factors suggest that today’s geopolitical dynamic is capable of instilling fear of short-term supply disruptions:
1) Chinese reserve-build policy and forceful effort to obtain production capacity abroad (East and South China Seas)
2) Political Unrest in OPEC’s second largest producing country
3) Supply restraints imposed on Ukraine
On Friday June 6th we hosted guest speaker, Professor Charles Hill to highlight some of the axioms of these three points of concern:
The EIA estimates that southern Iraq holds about 75% of the country’s proven reserves. Iraq shipped 3.3MM barrels/day last month on average and it ranks second in oil exports among OPEC countries behind Saudi Arabia. All of May’s exports were shipped out of southern ports. ISIL militants were successful in seizing the Kirkuk-Ceyhan pipeline, halting repairs, and taking Iraq’s second-biggest city, Mosul, but oil has ceased had flowing through this Mediterranean port since March 2nd. Nevertheless ISIL has successfully halted stopped the repairing of this pipeline which is capable of exporting 310K barrels/day. Abdalla El-Badri, Secretary General of OPEC, said yesterday in front of the World Petroleum Congress that Iraq will maintain its production limit of 300MM barrels/day for now. Iraq successfully shipped 5.43M barrels of oil from Basra in Southern Iraq on Friday and supply disruptions have not yet materialized.
Trending along the bottom, not worse but not significantly better...but that's a directional improvement.
Corporate Line of Credit $64m outstanding
Leverage 6.2x for covenant purposes
Retired $90m of debt, leverage down 0.25x
Capacity $184 million
D&A: $80-$82 million
Int Exp: $83-$85 million
Maintenance capex $47-50 million
Q & A
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Takeaway: May's headline starts/permits print looks soft, and upon closer inspection...is soft.
Our Hedgeye Housing Compendium table (below) aspires to present the state of the housing market in a visually-friendly format that takes about 30 seconds to consume.
Today's Focus: May Housing Starts & Permits
The Census Bureau released its monthly Housing Starts & Permits data for May this morning. The big takeaway is this: No Growth.
Summarily, activity was weak across the board as both SF and MF starts declined, permits went sub-1MM, and single family starts and permits re-coupled at the low 600K level.
The lone source of relative strength was the sequential rise (+3.7% MoM) in SF permits, however, the YTD trend in permits continues to suggest softish forward starts figures.
While total starts and permits bounced sharply in April they were down in May. More importantly, however, the Single family component showed little-to-no signs of life in April and was down again m/m in May (SF starts down -5.9% m/m). Yesterday’s sequentially improved NAHB HMI print of 49 seems at odds with today's continuation of the soft single family data.
Three factors are principally responsible for the ongoing weak 1H14 performance for housing. First, QM rules that took effect on January 10 of this year are having a suppressing effect on credit availability. Second, institutional investor demand for properties is waning sharply. Third, affordability dynamics have swung sharply; whereas 12-18 months ago there was a strong asymmetry favoring homeownership, today renting vs owning are close to a toss-up.
About Housing Starts & Permits:
The US Census Bureau records the number of new housing units that have obtained permits for construction and those that have begun construction. This data includes new buildings intended primarily as residential units. The US Census Bureau defines a start as, “Start of construction occurs when excavation begins for the footings or foundation of a building.”
Joshua Steiner, CFA
Christian B. Drake
Takeaway: ICSC - QTD growth rate flat to last year. JCP gets a slap on the wrist over MSO agreement. WMT investing in e-comm talent.
EVENTS TO WATCH
ICSC - Chain Store Sales Index
Takeaway: Two solid weeks of data. Plus 3% and 3.1% YY over the past two weeks respectively. QTD growth rate is flat to last year.
JCP, M - Macy's Wins Case Against J.C. Penney
Takeaway: Looks like Penney's will walk away from this with a slap on the wrist. M prolonged the case in an attempt to inflict maximum pain on JCP. The irony is that this is behavior that is typical of wanting to hurt a financially-strained competitor. We're not beating Macy's up over this -- it's what companies do. But, Macy's management will swear all day that it does not compete with JCP. The big loser in this whole mess is MSO.
WMT - @WalmartLabs Grabs Its First “Silicon Alley” Startup With Acquisition Of Fashion App Stylr
Takeaway: WMT continues to invest in talent. The company has recognized the importance of this channel for its long term growth algorithm and is investing accordingly. Compare that to the guys in Minneapolis who formed a Digital Advisory Council to solve TGT's e-commerce problem.
TGT - Target: Device glitch caused check-out delays
KSS, SHOO - Juicy Couture, Steve Madden Partner for Footwear
WWW - Wolverine Worldwide Announces Key Leadership Changes And Additions To Accelerate Global Growth
WMT - Wal-Mart to Triple Spending on Food-Safety in China
GIII - G-III Apparel Group, Ltd. Announces European License for G.H. Bass Footwear
UHR - Swatch Waiting With Apple for Smartwatch Market to Grow
NKE, JD Sports - JD Sports Fashion jumps 3% after World Cup boost
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