SHORT COPPER: Fundamentals Riding The Quant Set-UP

Takeaway: After sending the "Reduce EM Exposure" message via the “MACRO PLAYBOOK,” fundamental headwinds pressuring copper prices have a catalyst.

Earlier today, we sent out the EM sell signals in our MACRO PLAYBOOK one pager with the following conclusions:

  • VWO (Vanguard Emerging Markets ETF) broke @Hedgeye TREND support yesterday
  • TACRM generating a high-conviction “SELL” for EM equities with major downside given the crowd-chasing out-performance over the last 6-months
  • SELL: China (ETF: FXI), India (ETF: EPI), and Copper (ETF: JJC)
  • BUY: Muni-Bonds (ETF: MUB) and Domestic Mega Caps (OEF)

With regards to our copper position, the bearish fundamental thesis now has a catalyst:

  1. The recent turn in emerging market equities fueled by:
  2. deflationary pressure on USD denominated commodities in a QUAD 4 set-up in our internal GIP model (GROWTH AND INFLATION SLOWING)

Copper has gone through a BULLISH TO BEARISH TREND REVERSAL, and the fundamental supply/demand outlook over the longer-term supports the short copper thesis.

While a slowdown in the commodity fueled credit financing bubble in China and the expectation for a steady increase in global supply coming onto the market over the next two years have suggested lower prices for quite some time now, a 1) A BULLISH Quant set-up in Chinese equities fueled by the positive effects of monetary stimulus at the regional and local government level from Beijing; AND 2) a BULLISH quant set-up in copper, likely fueled by the Chinese catalyst (SEE BELOW), helped to support prices over the summer.



  • Reduce Exposure: EM Equities


Copper ($Spot):

TREND: $3.16

TAIL: $3.20


SHORT COPPER: Fundamentals Riding The Quant Set-UP - chart1 spot levels



TREND: $38.46

TAIL: $38.99


SHORT COPPER: Fundamentals Riding The Quant Set-UP - chart2 ETF Levels


With market activity working with the downside price move  to confirm the bearish set-up, market activity and current sentiment suggest  perception of the next catalyst has the ability to induce outsized moves in either direction.  



  • 5-Day -3.2%
  • 1-month: -5%
  • YTD: -10.4%


  • Implied volatility vs. trailing averages:
    • -9.3% vs. 1-month
    • -1.0% vs. 1-month
    • -6.8% vs. 6-month


  • CFTC Data showing a market that is chasing price but not overextended:
    • Net Futures and Options Positions: -28% shorter week-over-week:
      • -13.5K contracts vs. -577 1-year average (z-score=-0.85x)

Data showing the net positions from money managers reveals open interest is at a 7-week high: 

  • LME Money Manager Open interest: INCREASING
  • Money Manager Longs % Open Interest: INCREASING
  • Money Manager Shorts % Open Interest: DECREASING

SHORT COPPER: Fundamentals Riding The Quant Set-UP - chart 3 money managers agg. open interest


The market as a whole is shorter as evidenced by the commitments of traders reports released Friday by the CFTC, but the speculative positions by large money managers is increasing. At the same time, volatility is being sold for less than its trailing averages. When this occurs, the probability increases for price movements that test critical capitulation levels compresses. The expectation for less volatility with larger, speculative size behind a market is the perfect set-up for more volatility on a catalyst. 

  1. Bigger Positions: CFTC leaning farther short and money managers increasing open interest
  2. Implied Volatility being sold for less than trailing near-term averages
  3. Realized volatility lower than trailing averages
  4. Negative correlation risk vs. the U.S. dollar

While copper is down -10% on the year, we believe a cyclical downtrend has much farther to run over the next few years.

Please see the links below for two previous notes outlining the fundamental headwinds that will continue pressuring copper prices over the intermediate to long-term. We’ll follow-up with additional data supporting the call in the coming weeks. At the time of publication of these two notes, copper was in a BULLISH TREND set-up making the fundamental picture look obsolete.

The first note outlines China’s share of global base metals demand and proceeds to outline how the expectation for over-extended demand growth looks unsustainable from here.




Highlights from the Note:

  • CHINESE DEMAND: China consumes over 40% of the world’s industrial metals (up from 5% in 1980).
    • 2013 Consumption (% global demand):

-         Nickel: 47.4%

-         Aluminum: 46.1%

-         Zinc: 45.6%

-         Copper: 42.4%

  • INDUSTRIAL METALS TRADE ON THE OUTLOOK FOR CHINESE GROWTH: An equally weighted index of Chinese GDP and industrial production to industrial metals prices (CRB metals index) is running an r-squared of 0.50 currently, down from a December 2011 peak.
  • COMMODITY FUELED CREDIT GROWTH (ADMITEDLY VERY ELUSIVE): Goldman Sachs estimates that $160Bn has flowed into China through commodity-backed loans since 2010. Regardless, the argument that this scandal has helped fuel an unsustainable credit boom has been labeled a bearish signal for base metals. A few cracks in the investigation by the Chinese government have found cracks in the bubble recently:
    • Multiple parties using the same metal stockpiles as collateral
    • Reports emerged last week that a major Chinese trading house is on the verge of insolvency
    • Iron Ore Stockpiles at Qingdao port at lowest level since 2009
  • INVESTMENT: China’s consumption to investment ratio (consumer demand/cap-ex ) is at historical highs:
    • China: 0.7x
    • USA: 3.5x
    • UK: 4.6x
    • Eurozone: 3.3x
    • Aggregate debt level has reached 251% of GDP as of June which is a 20% increase from late 2013.
    • Debt/GDP levels have increased 100% over the last five years
    • China’s $26 trillion of debt is more than the entire commercial banking system of the U.S. and Japan combined
  • DEMAND TO MEET SUPPLY FLOOD? On the supply side, an increase in late cycle mining cap-ex anchoring on steady demand from China moving forward requires an unsustainable amount of consumption from China if recent manufacturing and housing data is any indication:

In the following update at the end of August, copper was on the verge of breaking down. We highlighted Jakarta’s reversal to its copper bauxite export ban put in place in January. While Indonesia isn’t near the top of copper producing countries, China’s move to diversify supply lines elsewhere, and Indonesia’s mid-year lift on the ban will add to what we see as an excess amount of supply coming on over the next few years.


Is Indonesia's export Ban on Copper Bauxite Nearing a Resolution?


The following quote from the note highlights our conclusions:


“We will be watching the following factors in the coming weeks for a read-through on the supply outlook:

1)      Chinese economic outlook takes a more definitive turn positive or negative

2)      The Indonesian copper bauxite export picture reaches a long-term resolution

3)      Continued confirmation in a late-cycle mining cap-ex push from the largest miners

4)      A continued positive Trend for the USD


With these fundamental factors in play, copper may be interesting on the short-side if our @Hedgeye $3.16 TREND line breaks and confirms.”


This TREND Line of support did in fact break, and to re-iterate, copper is now BEARISH from an intermediate-term TREND perspective with $3.16 now a RESISTANCE level. With the quant now agreeing with the fundamental picture, we will look to short copper on the oversold risk management signals. 

Please reach out with any comments or questions.


Ben Ryan



Cartoon of the Day: Small-Cap Canaries?

Takeaway: At 55x trailing earnings and 42% of the names in the Russell 2000 crashing (-20% or more from 12 month peak), the US stock market is cheap?

Cartoon of the Day: Small-Cap Canaries? - Small cap canaries 09.23.2014


Takeaway: Good 3Q beat but the focus is now on 2015 costs and whether Europe momentum can be sustained.

Given trends seen from our pricing survey, we believed a F3Q beat was already in the bag with the Caribbean, while slowly improving, still limping along in a tough promotional environment.  The ECA cost impact may be a little above expectations but more importantly, we wonder if the exuberance on Europe is overstated heading into 2015.






  • Steady progress in both Carnival and Costa brands in F3Q
  • 3Q confirmed Carnival turned the corner
  • Notable lengthening of bookings curve across European brands
  • NA/Europe bookings/pricing higher for 1H 2015
  • Yield growth can be sustained
  • Without mitigation, ECA requirements were originally expected to reduce EPS by $0.75.  But with new technology, limited ECA impact to $0.10.
    • Technology initiatives:  propelling, lighting and air conditioning.
  • Costa:  seeing steady improvement in yield and profitability
  • New Princess ship:  only new build for 2014 and will sell Ocean Princess
  • China:  expect double digit growth over next few years
    • Already the largest cruise operator in mainland China (1st in market through Costa brand in 2006).
    • China operations have and are profitable.
    • 4 homeports (shifting) and 12 marketing offices
  • 3Q
    • Better rev yields (11 cents) - split btw ticket and onboard
    • Lower NCC ex fuel (3 cents)
    • Lower fuel prices (2 cents)
    • Net ticket yields turned positive in 3Q
    • Capacity increased 2% (NA: +4%, EAA: flat)
    • Occupancy:  point higher than June guidance
    • Net ticket yields:  + 0.7% (EAA: +4% led by continental Europe and China); NA yields: down just over 1% due to continued promotional pricing environment in Caribbean
    • Net onboard and other yields:  +5.5% (considerably more positive than anticipated), increases in almost all categories.
    • NCC ex fuel: up +0.5%, better than guidance due to timing of certain expenses
  • 4Q yield: expect NA brand net ticket yields will turn positive
  • Higher EPS for FY 2014 due to:  11 cents (better 3Q), 4 cents from fuel prices and currency.
  • 1H 2015:  
    • NA
      • Caribbean ahead on price and occupancy (56% of 1H 2015 capacity)
      • European program:  ahead on price and occupancy
      • Booking volumes good at nicely higher prices
    • EAA
      • Ahead on occupancy; prices in-line with prior year
      • Booking volumes higher YoY at slightly higher prices.
  • Expect to offset inflation in 2015
  • Aggressively rolling out EGCs.  16 ships beginning in FY 2015; 42 ships by end of 2015.

Q & A

  • 2015 costs:  2/3 of cost increases due to dry docks; 1/3 due to 'investment in various areas of the business in terms of deployment and occu.  Not afraid to reinvest in business to drive yields.
  • Double digit ROIC target:  3-5 yrs
  • Holding price while sacrificing occupancy is only a tactic; they will continue to use the tactic as long as it works
  • Casino to-date has not been strong on CCL ships.  CCL is purely a cruise product.
  • Chinese govt has a plan for cruise development
  • China:  Lost money in 2006, broke even in 2012, made money in 2013/2014
  • Additional onboard opportunities:  casino/restaurants/beverages
  •  $75-80m cost investments
  • Negotiations with airlines ongoing
  • NCC ex fuel (excluding dry costs):  flattish over 2015/2016
  • Carnival brand:  recovery a little faster than where mgmt forecasted
  • Caribbean:  very tough environment
  • Capex 2014:  $3 billion  (similar levels for 2015 and 2016)
  • China challenges:  challenge is to communicate what is a cruise to the consumer; cruise port development; availability of international ports; infrastructure development.
  • China:  most ships are chartered; customers purchasing through a distribution network
  • 2015 yield:   late 2Q and onward should show better yields for Caribbean due to capacity reduction.
  • Evaluating where some of Costa's/Princess's Asia ships will continue to use Euro functional currency
  • May explore China partnership; Carnival chief operating officer Alan Buckelew will relocate to Shanghai.
  • 2014 NCC ex fuel guidance raised:  unexpected pension expense and some other expenses bumped the range up slightly.
  • 2/3 of dry dock costs in 2015 will disappear in 2016. 
  • Optimistic on both NA and Europe in 2015
  • 10 cent ECA cost:  early season dry dock may offset a little of that; much of 10 cents will be eliminated in 2016 and gone by 2017 due to ECG implementations.
  • 1% change in fuel efficiency equates to 2.6 cents in EPS.  Expect 2-3% fuel consumption improvement going forward. 
  • Raised ticket and onboard guidance for 4Q
  • Industry seems to be at or very near 2007 peak levels (mostly not coming from Carnival)
  • Not worried about the new ships coming on line; industry capacity growth still manageable.  Expect Asia to absorb much of the additional capacity.
  • 2014 Net ticket yield increase:  50% from occupancy, 50% from higher prices
  • Booking curve:  85%-95% (next Q), 50% (2Q out) 25% (3Q out).


investing ideas

Risk Managed Long Term Investing for Pros

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An Epic Bubble in Small Caps (And Why Market Illiquidity Remains One of Our Biggest Concerns)


In this excerpt from today's Morning Macro Call, Hedgeye CEO Keith McCullough discusses the recent trend we’ve been highlighting of down moves in U.S. stocks on greater-than-usual volume, and why investors need to be particularly careful right now with respect to the bubble in small cap stocks.


Takeaway: The Hedgeye Macro Playbook is a daily 1-page summary of our core ETF recommendations, investment themes and noteworthy quantitative signals.

CLICK HERE to view the document.


Best of luck out there,


Darius Dale

Associate: Macro Team

Texas Instruments: A Top Mega-Cap Long in Chip Sector | $TXN

Takeaway: Take a closer look at Texas Instruments.

In a macro environment where investors are rotating into the largest capitalization stocks, Hedgeye Semiconductors sector head Craig Berger likes TXN as the top mega-cap stock in his sector.  TXN just raised their dividend from 30 cents to 34 cents, a 13% increase, to now yield 2.7%.  Despite having raised their dividend numerous times, Berger says TXN still only pays out 35% of their free cash flow, giving them lots of room to increase dividends again in the future. The firm is also repurchasing much stock on the open market.


Texas Instruments: A Top Mega-Cap Long in Chip Sector | $TXN - 78t


TXN compares favorably to the other giant names in the space: Intel (INTC) earnings have already grown meaningfully, could be toppy, and are vulnerable to ongoing deterioration in PC demand.  The other biggest name in the Semiconductor space is QCOM. Berger is also constructive on QCOM given strength in iPhone 6 and 6 Plus smartphone shipments (where QCOM supplies the main communications processor), but Berger says “QCOM is in the penalty box in China” as the Chinese ramp their protectionist policies and push to stimulate domestic Chinese production. Given the size and scope of the Chinese consumer, this could be an ongoing headwind to QCOM shares.


TXN doesn’t have the China exposure that QCOM has, and it is also not tied to the PC market the way INTC is.  After buying a Japanese memory manufacturing facility for pennies on the dollar, TXN’s production capacity is only 2/3 utilized.  Berger says this investment could pay off huge, as TXN is now the only in-house producer of larger 300mm (12-inch) analog wafers, giving them a global leading cost structure. Their sizable cash flow generation and underutilized capacity make TXN a possible large-scale acquirer.  They could gobble up a big competitor and push all this production through their existing fabrication capacity.  Even with added personnel and manufacturing costs, Berger says 80 cents of each incremental dollar would drop right to TXN’s bottom line.  In a market that’s looking for quality mega-cap names, TXN looks like it has all the ingredients.


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