Ripples in Russia

This year we've been cautious in pointing out the risk premium associated with owning Russia, yet assertive that Russia's commodity based economy stands to benefit greatly from commodity reflation, a major theme of ours in the first half of this year. 

The Russian stock market (much like other countries that are paid in petrodollars) has followed the price of oil like a hawk year to date, with a correlation coefficient (R squared) of .94 between the RTSI and the continuous front month light sweet crude contract (see chart). This year we've frequently commented on Russia's performance as it vied for the best performing global market with the other BRIC components, until it began pulling back in concert with oil.  Starting June 1st the RTS declined 28.5% with oil down 12.0% in the same period, before catching a bid this week, up 10.6% on oil's 6.4% run.

While the price of energy commodities and metals remain the central catalyst for the Russian market, we're equally watching the country's underlying economic fundaments as we believe they'll drag down performance on an intermediate and TAIL (3 years or less) basis, especially should oil stay under our TAIL resistance level of $67.78/barrel.

This week the Russia's Economy Ministry updated its economic forecast. Whether the information is completely creditable or not is a matter of discussion in itself, however the Ministry reported that GDP may decline 8.5% this year, after contracting 9.8% Y/Y in Q1 (the most in 15 years) and that Russia may not match last year's growth until 2012.

On the ground industrial production was down 17% in May, with the IMF forecasting unemployment at 13% this year.   Wage arrears rose 10.8% and according to a study by Moscow's Higher School of Economics--and not surprisingly--Russia is seeing a rise in labor unrest with a recorded 99 labor disputes in the first five months (nearly the same level as in all of last year). 

While the data may be questionable, the country's demographics support a grim picture for future growth.  The World Bank reported that by the end of this year 17.4% of the population (24.6 Million) will live beneath the subsistence level of $185 per month, about 5% more than before the crisis. Additionally the Economy Ministry said Russia's working population will annually decrease by ~1 Million every year over the next three, and the population will continue to decline, as it has over the last 14 years; last year the population stood at 141.9 Million.

From a fiscal and monetary perspective Russia is certainly trying to weather the storm, but we'd argue that the Kremlin is not doing enough. The country issued a stimulus package of more than 2.5 Trillion Rubles ($80 Billion -a puny amount in context), and has reduced interest rates to stem the blockage in credit lending. Over the last three months Bank Rossii has cut interest rates three times, shaving off 50bps to 11% in its last cut on July 10th.  

The chart below helps to frame the USD-RUB dynamic along with the price of oil. Certainly the Central Bank has played a large role in manipulating the Ruble's value over the last year, having drained some $200 Billion (1/3 of the country's foreign-exchange reserves) from August to January to stem the Ruble's slide versus the dollar as oil came down off its summer highs. Most recently, the bank reported that international reserves slid by $8.4 Billion to $400.7 Billion last week, the largest decline in almost in six months, as the Bank attempts to strengthen the Ruble. 

All of this action begs the question: to what extent the Central bank is willing to support a strong Ruble policy (and ensure it trades below the high side of its trading band of 26 to 41 against a basket of Euros and Dollars) if oil continues to fall? On one hand, Russia has the reserves to support currency, yet the bank has no control over investors who may flee due to the volatility of a economy levered to energy prices.  

Make no mistake, the Russian stock market is focused squarely on Oil and Gas, yet our work in global macro has taught us that a country's fundamentals drive market performance in the long run. As outlined, on the TAIL there are real risks in the Russian economy and, perhaps more importantly, real political risks to investing there.

In the immediate term, we will continue to analyze all data points -large or small,  made up or not, as we look for signals on the margin that may change our stance.

Matthew Hedrick

Ripples in Russia - russia



We think the Chinese government wants Lots 5 & 6 restarted by the end of 2009. Importantly, Beijing may be "persuading" Chinese lenders to help with financing.

"I'm gonna make him an offer he can't refuse" - Vito Corleone

We think the Chinese government wants Lots 5 & 6 restarted by the end of 2009. Importantly, Beijing may be "persuading" Chinese lenders to help with financing.

The way Beijing sees it, the LVS/Lots 5 & 6 situation can go in three ways:

  • LVS and a developer reach an agreement and Chinese banks provide the financing
  • LVS sells Lots 5 & 6 to a developer and SJM operates the casino
  • LVS hangs in the wind

We think Beijing has already introduced LVS to contractors and Chinese financial institutions to facilitate construction re-starting.  So far, we are hearing that LVS's offering terms are not satisfactory to at least a few contractors.  Other potential developers include Far East Development and New World Development.

Once an agreement is reached, it looks like Beijing may be willing to twist the arms of some banks to provide financing for the project as well as solve LVS's covenant problem.  Our sources tell us that LVS's financing issues are essentially "solved".

Our research continues to indicate that LVS will overcome its financing issues through refinancing, bank debt buybacks, or an IPO.  As we've stated in the past, an IPO likely will not be completed until November at the earliest meaning LVS must deliver on the other options in the meantime.

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Eye on Commodity Prices

Commodity prices continue to look favorable for the restaurant companies on a YOY basis. Even chicken, which is the only commodity within the more prevalent restaurant basket of commodities that has been up on a YOY basis for the first half of 2009, is now flat with 2008 prices. Milk and cheese prices are maintaining their historically low levels but have increased slightly in the last two days. Gas prices, which have moved higher rather steadily year-to-date (up 57%), have come down slightly in recent weeks.

Commodity outlook from those companies first to report earnings:

YUM 2Q09 earnings call: "Despite a slight sales decline in U.S. sales, we saw second quarter restaurant margin increase by over two full points. We are seeing a dramatically improved commodity cost environment in the U.S. For the first time in quite a while, we saw commodity cost deflation of $4 million in the quarter....In fact, we expect to see significant improvement in year-over-year commodity costs in both the U.S. and China. For the balance of this year, we anticipate commodity deflation of about $10 million in the U.S. and commodity deflation of nearly $50 million in China."

RT 4Q09 earnings call: "In general, we continue to experience favorable commodity costs....Our commodity cost was solid, we don't anticipate really any increases there for this year."

Based on RT's and SONC's comments at an investor conference this week that they are seeing a heightened level of discounting now even relative to recent months, this increased commodity favorability may not be enough to protect margins. To that end, Chili's launched a promotion earlier this week for a $20 three- course meal for 2 guests. The nationwide, limited time offer includes a shared appetizer, two entrees and a shared dessert. Chili's offer follows Applebee's popular 2 for $20 deal, which does not include dessert. With deals like this becoming the norm, restaurant margins are at risk in 2H09 even in light of the YOY decline in commodity prices.

Eye on Commodity Prices - Commodity prices

Eye on Commodity Prices - Commodity chicken

Eye on Commodity Prices - Commodity milk

Eye on Commodity Prices - Commodity cheese



Range Rover, Refreshed!

Even a blind hockey monkey like me can find the right levels once in a while. The Q3 Macro Theme levels that we issued at the beginning of the month continue to hold, so I am staying with the intermediate term plan. Buy 871; Sell 954.

In the chart below I have outlined these lines and included my immediate term TRADE line of support, which is now 912 (dotted green). There is no reason why the SP500 can't drop to 912 as fast as it shot above it.

On the open I made more sales, taking my longs versus shorts in the virtual portfolio to 18 (longs) 14 (shorts). In early July I was running 5:1 longs to shorts. Another way to look at how I think about managing risk around a proactively predictable range is my gross exposure in the Asset Allocation model. On July 9th (see chart) I had a 38% cash position. Right here and now I have taken that all the way back up to a 65% position in US Cash.

Being long US Cash is an investment position. Particularly as the US Dollar Index reaches an oversold level, and the SP500 approaches being overbought.

Trade the Range Rover, and best of luck out there,


 Range Rover, Refreshed! - tailchart

Keith R. McCullough
Chief Executive Officer



It has been a year since the Macau government first began suggesting that junket commissions be capped by law.  Thus far, no law has been enacted and casinos have discussed and, in some cases, implemented a cap of their own accord.  The Venetian and City of Dreams have taken the lead in this regard, with their 1.25% commission caps being brought into effect since July 1.

Concerns remain: can they trust each other to stick to the deal? Rumor has it several junkets have been telling Venetian that COD has breached the cap, and vice versa.  Can they avoid losing business to the other thirty properties in Macau who are free to pay higher commissions to junket operators?  This operator suggests that the best solution is for there to be a unilateral cap enforced by an "independent regulator" - the government.  Until political will emerges, he writes, an enforceable and across-the-board cap looks unlikely.



Destination Macau has heard of big players pushing back on the Venetian's decision to implement a junket commission cap but cites an "informed source" as saying, "it has made no impact to our business".  COD claims that the decision is about "optimizing table performance" and focusing on the direct-player business - high-rollers who prefer to play with their own credit and don't need junket services.  DM says that this was a risky move for the Cotai properties, but there could be other ways in which COD and Venetian can accommodate the junkets, "i.e. with performance bonuses that involve a revenue-share split.



According to Macau Business, Chui told a group of more than 100 gaming industry executives that, "I have collected a lot of opinions and understand that decreasing the gaming tax can increase the competitiveness of the gaming sector." A change in the gaming tax would require legislative ratification, and while Chui isn't committing to any action he's letting the market know that he understands the concern that Macau gaming revenues could be negatively impacted by Singapore which has only a 5% tax rate compared to a 39% gaming tax in Macau. 

However, any revisions would not occur until after observing the impact, if any, of the Marina Bay Sands and Genting's ResortsWorld. 

There is also a question of who exactly will benefit from a tax cut. The obvious conclusion is that a tax cut would flow through to the bottom line of the concessionaires, but junkets will surely want their cut as well, which will likely manifest itself in higher commissions. Do not be surprised if there is a compromise between Chui, the Big Six, and the junkets, but it will take some time.



What Sheldon Adelson's options are for raising money has become a subject of speculation of late.  He has said that an IPO on the Hong Kong stock exchange is an option, an asset sale is another, construction financing on Lot 5&6 is another, and a private placement of equity in his Macau entity is yet another option.  Which one, or which combination, he chooses remains to be seen.  The other question remains whether all the options are even viable given current market conditions.

The recent admission that LVS is in talks with holders of its Macau debt on the terms they have for repayment of US$3.5 billion is seen as a sign that time may not be on Adelson's side, according to DM.  Whether some of the aforementioned capital-raising options are off the table is unknown.  DM is hearing that Adelson has to raise money from Macau assets in order to fund the finishing of the Marina Bay Sands.  The assets are obviously not entirely in his control so the only way for him to free them up will be to "relinquish control of the Macau operations - for a premium."  DM admits that the source on this story is biased and that Adelson still has plenty of gas (his net worth) in the tank.



The Macau government has implemented a scheme to subsidize homebuyers.  The plan has attracted a large number of applicants and pushed up property prices.  The prices of secondary market flats have risen by about 30% since January - back to pre-global meltdown levels.  Residents buying flats worth no more than 2.6 million patacas with a mortgage can apply for an interest subsidy of up to 4% under the scheme.

Lawmakers are concerned that the scheme may inflate home prices and entice buyers into a trap of negative equity. An anonymous property agent is cited as saying that a number of people had bought flats in April and May and were now preparing to "sell" them to their children who were applying for the scheme.



David Chow announced this week that he will demolish the Tang Dynasty shopping store and pour another HK$3 billion into the first phase of his redevelopment of Fisherman's Wharf, acknowledging that his project on the waterfront has not lived up to expectations. DM sees it as being an intelligent move. Building new hotels and enclosing the amphitheatre to make it possible to do all-weather shows will give Fisherman's Wharf a better chance of attracting people to the property on the peninsula. 

More investment is planned for the redevelopment; it will require HK$8 billion to finish altogether.  Once finished, SJM will have the Sands surrounded...



Despite its stated intention of butting 3,000-4,000 jobs at the Venetian Macao, Sands Macao, and "Parcel Two", the Venetian Macau Limited has opened its arms to local residents by offering them "hundreds of jobs" at the Venetian Macau Resort-Hotel and the Sands Macao Hotel.



DM admires StarWorld's recent performance - packing the main gaming floor and improving its win-per-table numbers for a few weeks now by closing half of it for renovations.  The newly refurbished area, which opened this week, is extremely impressive and is being well-received.

Ahead of L'Arc opening next door on September 21, StarWorld is clearly going upmarket.  The appearance and atmosphere of the property has been enhanced. 

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 80.47%
  • SHORT SIGNALS 78.70%