Position: Short Japan via the EWJ

The BOJ’s Tankan business confidence index data for March registered the lowest levels since inception in 1974 when it was released this morning.  The Tankan indices are calculated from surveys of a broad swath of Japanese private enterprise, representing a view on how favorable conditions are perceived to be near term. Unsurprisingly the manufacturing sector registered the most negative levels, arriving at -59 in the face of collapsed foreign demand. Ominously for Japanese unemployment levels (which yesterday registered at a three year high) and capital investments, the data showed conditions were worse for mid-sized and small companies which are less likely to receive government stimulus directly and have been particularly hard hit by the credit contraction.


Non manufacturing segments are not being spared either as Japanese consumers return to the low spending levels that they adopted during the prior “lost decade”.  As with manufacturers, the sentiment among smaller consumer and service sector companies was significantly more negative than among larger ones.

As sentiment sinks, the Aso administration continues to hide details of the size and scope of the much heralded third stimulus package, which will be announced in the coming weeks.  This political strategy bears the strong risk of creating high expectations among investors who will inevitably be disappointed by the actual package. We retain a negative bias on the Japanese economy and see the primary driver for equities there, which we are short via EWJ, to be currency valuation. Only a weak Yen can push stocks higher in the absence of rebounding external demand.

Andrew Barber


Natural Gas: Production is Key

Position: No position in portfolio currently

From a commodity perspective this year, we have been primarily focused on copper and oil over the last few months.  This is driven both by our re-flation thesis, under which global priced commodities such as copper and oil benefit, and also our bullish stance on China, which is the home of the majority of incremental demand for these commodities globally.   Lately, natural gas has started to come on our radar screens, but for vastly different reasons.

Unlike its use of oil, the United States is largely self sufficient in its use of natural gas.  In 2007, the U.S. produced 19.3 billion cubic feet annually and consumed 23.1 billion cubic feet, for a net import number of 3.8 billion cubic feet.   More than 95% of the net import number for natural gas comes from Canada, which in aggregate makes North America highly self sufficient in its production and use of the commodity.  Unlike oil, the continent is not a net importer for natural gas.

The implication of this is that natural gas is a commodity that is priced much more on basic supply and demand versus oil which is priced partially on natural supply and demand, but also based on geopolitical risks and actions of regional cartels, primarily OPEC.

In the United States, ~28.7% of natural gas is used in the economically sensitive industrial sector.  In economically weak times, demand from the industrial sector declines.  In late 2008, it was a perfect storm for natural gas with a weak economy leading to declines in consumption combined with a natural gas production profile that was increasing at an accelerated rate due to high natural gas prices, which prompted more drilling, and due to a number of the large shale plays coming online.  In the table below, y-o-y growth in natural gas production in the U.S. is summarized:

Natural Gas: Production is Key - chart

The key take away from the table above is that U.S. natural gas production growth on a y-o-y basis was well above its historical norm for the last 6 months of 2008.  We calculated the CAGR for U.S. y-o-y production growth from 1990 to 2008 and the CAGR was 0.80%.  The CAGR in consumption for that period was 0.96%, which implies that historically, at least for the last two decades, the industry acts relatively efficiently in terms of production additions.  This 5.4% growth that we witnessed in the last 6-months of 2008 was well above historical norms.  Not surprisingly, gas in storage is up 372 Bcf, or 22.4% y-o-y, as of March 20th.

The key to thinking about the inflection point for natural gas from a supply and demand perspective is to determine the rate of decline in drilling, which will lead to declining production that will push the market back into balance and obviously stabilize pricing.  Over the next couple of weeks, we will be surveying some of our contacts in the natural gas fields of North America to get more perspective.

Daryl G. Jones
Managing Director

 Natural Gas: Production is Key - image001 1

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Ukraine and Kazakhstan Making up the Rules

There’s early indication that the Ukraine and Kazakhstan want to prevent capital flight through outright taxation on investment withdrawals and may require exporters to sell some or all of their foreign-currency earnings to the Central Bank at rates it indicates.

So much for free market Capitalism…welcome socialist Regulation!

Ukraine and Kazakhstan are among the countries often referred to as “Eastern Europe,”  a region that has been plagued with double digit declines in stock market performance YTD (despite upticks in March) and severe currency devaluation over the last six months due to the global recession, especially as demand from the Eurozone, the region’s main trading market, has been smashed.

Kazakhstan and the Ukraine, both heavily dependent on commodity exports (oil, steel, and agricultural commodities) have been hammered in particular by oil’s price plunge since its highs in the summer of last year. Oil’s deflationary pressure has helped increase default risk on foreign-denominated debt, leading to the IMF bailing out the Ukraine to the tune of $16.4 Billion late last year. The Ukraine used some $12 Billion to purchase the local Hryvnia to prevent it from being dangerously devalued, the outcome of which depleted its currency reserves.

Now the Ukraine and Kazakhstan, both desperate for foreign currency to bolster its reserves, are preventing their banks from returning money to investors in foreign denominated currency and may prevent companies from paying dividends to international shareholders. Additionally it’s being reported that the governments are compelling exporters to sell foreign-exchange earnings to the government for local tender. 

The new rules and controls the government hopes to levy to protect against the flight of foreign capital and augment currency reserves will only encourage investor to flee amongst the uncertainty of policy. Foreign investment is paramount for these emerging market countries, and these measures will surely be antithetical for foreign investment needed to aid these struggling countries.

Matthew Hedrick


Position: We are short the Indian equity market via IFN

The past weeks have been full of mixed blessing for the Indian economy: Tata’s triumphant launch of the Nano, an emblem of India’s ambitions and potential, was marred somewhat by capacity constraints that will prevent production sufficient to meet anticipated full demand until 2011, a full year later than hoped. After weather worries, the wheat harvest is now projected to be a record haul lifting concerns about consumer price pressure, but with collapsing wholesale prices the prospect of cheaper wheat provided little comfort to the more than 50% of the population that toil as small farm operators.

February export data released by the ministry of commerce today leaves little room for positive interpretation however, as collapsing global demand reverberates through the subcontinent’s manufacturing sector. Exports declined by 22% on a year-over-year basis in February as total exports fell at a greater rate of 23% narrowing the trade deficit to $4.9 billion for the month.  Excluding oil (for which India is import dependant) imports declined by 10% Y/Y.


Since we launched our macro product early last year we have been consistently bearish on Indian equities. The divergence between our view and the India bulls has largely centered on our more negative bias on the potential for internal demand to sustain at high-single-digit growth levels. The glass half full community sees India as the major Asian economy with the least dependence on external demand while we see a massive mismatch between the vaunted drivers of the “Indian Miracle” –high tech services and intellectual property firms, and the reality of the great majority of India’s population that cannot possibly replace foreign demand for call centers and software.  Meanwhile viable products like the Nano, the model T of India poised to meet massive internal demand, have been hindered by bad governmental policies and a dependence of foreign capital (recall that Tata was forced to walk away from a nearly complete factory to produce the Nano after a regional government failed to satisfy the disgruntled farmers whose land had been appropriated for the site, setting the project back by months at massive expense).

Prime Minister Singh is in London today for the G20, and as both the leader of a rising global economic force and a talented economist his ideas will weigh heavily in the talks. At home however, with election starting before month end, the Prime Minister is scrambling to implement more stimulus measures  -rate cuts, tax cuts and infrastructure programs, which may satisfy voters even if the defense it will provide to economic growth is unclear. In the case of infrastructure projects, it is important to note that the ponderous overlapping bureaucracies of India’s state and federal governments will prevent ground from being broken for months or even years on most projects. Wholesale price levels released later this week may well register negative, but consumer inflation data has still not reflected the decline in commodity prices. In the face of all this, the any optimistic rhetoric by the ruling coalition going into the election needs to be discounted.

We are short the Indian equity market via IFN and continue to have a bearish bias despite the fact that the position has been a drag on our portfolio performance over the past month as the market rallied from January lows; the sting is softened by the long string of double and high single digit returns that we have realized shorting IFN over the past year.

Andrew Barber



Just last week, CKR management stated that Carl’s Jr.’s fiscal 2010 period 2 same-store sales would be down mid single digits as a result of a difficult comparison and continued discounting by its competitors. Today, we learned that Carl’s Jr.’s comparable sales trends were actually worse than management’s guidance as they declined 7% in period 2 (which I recognize as more of a high single digit decline). Despite this worse than expected result in period 2, Carl’s Jr.’s 2-year average trends did improve sequentially from period 1, but remained negative. Again, management blamed the concept’s weakness on “headwinds we faced from the ongoing deep discounting of low-quality menu items by our competitors, which negatively impacted sales at both our brands.”


Management stated in its press release that it is “working diligently to get Carl’s Jr. back on the positive same store sales track” and then goes on to say that “keeping with our strategy of offering our guests a casual-dining quality burger at a fast-food price, Carl’s Jr. debuted the Kentucky Bourbon Burger on Mar. 11.” This new burger is being offered as one of the company’s Six Dollar Burgers. Management recognizes that it is its premium strategy focus that is hurting sales at Carl’s Jr. in this current environment, and yet, it seems to think that keeping with the strategy will work to return Carl’s Jr. to positive same-store sales growth.

The company has proven that it is more difficult to hold the line on value as sales declines worsen because Carl’s Jr. returned its Jumbo Chili Dogs to the menu, which sell 2 for $3. But, again, in keeping with its more premium-focused strategy, management stated on its earnings call last week that it would not use media support for its lower priced items, including the 1/8 lb. burgers it expects to return to the menu.

Same-store sales at Hardee’s grew 3.1% in period 2 versus the concept’s easiest comparison from FY09. Ironically enough, the company said the comparable sales strength “validates the success of our premium product strategy.” So the premium strategy is helping Hardee’s and hurting Carl’s Jr.?

I understand the motivation for not wanting to discount. It hurts margins and could put the company’s brand positioning at risk, particularly once the economic environment improves. Holding the line on value in the near-term, however, is going to continue to put pressure on Carl’s Jr.’s sales performance relative to its competitors. As I have said before (please refer to my March 26 post titled “Is Market Share Shifting?”), I think that given the current casual dining discounts, the big market share shifts to QSR from casual dining are likely over. With casual dining restaurants offering more competitive value options, it will become increasingly more difficult for QSR players to win market share with premium-priced menu items. I think this is made clear by Carl’s Jr.’s declining same-store sales trends.

The issues at Carl’s Jr. have been magnified by today’s more challenging environment. Looking at the concept’s same-store transaction growth trends (please see chart below), 2-year average trends have been negative for some time now, highlighting the fact that trying to sell higher-priced menu items in a difficult economy is not the only problem facing Carl’s Jr.

CKR – WILL CARL’S JR. HOLD THE LINE ON VALUE? - CKR CJ Same store transaction

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