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Playing Chicken: Is It Time to Get Long Natural Gas?

We have thankfully stayed on the sidelines of the natural gas market this year and used our commodity wherewithal to successfully trade the oil and gold markets.  Broadly, commodities have been “ripping” this year on the back of U.S. dollar weakness and the perception of future inflation.   As many of you know, natural gas has much different price drivers than its commodity peers.  It is both a local commodity and very seasonal in nature. 


I grew up in the heart of the Western Canadian Sedimentary Basis (“WCSB”) in a little prairie outpost called Bassano, which is in the Canadian province of Alberta.  Only three things come out of Bassano – farmers, oil field workers, and hockey players. I was the latter.  Despite the luck, or perhaps misfortune in inflationary times, of being better at playing hockey versus growing wheat or drilling for oil / natural gas, I still know a thing or two about those commodities.   As it relates to natural gas, I can definitely tell you, supply matters.


Our Lead Desk Analyst Andrew Barber put together a chart below that outlines the supply of natural gas going back ten years.  As we can see, inventories for natural gas have been building steadily since September 2008, which has led to the dramatic and steady decline we have seen in the price of natural gas.


Portfolio managers at commodity funds across the continent are chasing performance and natural gas is the most washed out commodity. Naturally, they are asking their analysts, “Should we buy? Should we buy? Should we buy?”.  Everyone wants to call the bottom and natural gas does look washed out on many metrics.  That said, the supply data is bearish and likely to get worse. So we have a classic game of chicken going on.  The analysts know that fundamentals are bad, but the portfolio managers know that from a price perspective there is massive potential upside in “Natty”.  So, who will budge first, the price or the fundamentals?


Admittedly, we’ve had the same scenario internally.  Keith has hit me with his levels on the natural gas, and noted breakouts from a trade perspective, but I’ve had a hard time telling him I think he should pull the trigger.  Currently, as of the month of September, natural gas inventories in the United States are 17.7% above their 10-year average (the September bar on the bottom chart). 


Natural gas collapsed in August because storage levels were butting up against 80%, which is the max they can be prior to September, so excess natural gas was sold into the market, which depressed prices.  Storage can now be filled to 100% of capacity, so excess natural gas has been going into storage in September versus sold into the market, which has been a key driver of the price of natural gas this month.   Obviously, the commodity was also dramatically oversold and the economic outlook has improved, which have helped the rally.


Last week storage hit 88.9%, which is its highest level since 2006.  This is noteworthy in that we are only halfway through the month and storage will likely be at 100%, or close to it, by the end of the September.  The implication of this is that we may revisit the price dynamics of August in which no more gas could go into storage, so it was sold to the market which pushed prices down again.  This is obviously a short term dynamic, but I have to be honest, high inventories and the potential reality of storage being filled by late September are making me a little  . . . ummm . . . chicken.


Daryl G. Jones
Managing Director


Playing Chicken: Is It Time to Get Long Natural Gas? - ng2


Playing Chicken: Is It Time to Get Long Natural Gas? - a1


Game Time Call: Bernanke Burns The Buck...

Ben Bernanke, fully loaded with his new job security, still panders!


As incredible and scary as this completely politicized US Federal Reserve has become, we have no choice but to react to its compromised outputs. In our Pre-Game note, we noted that the US Dollar was strengthening alongside 2-year yields. Bernanke’s Game Time decision was to reverse that. Once again, he decided to Burn The Buck.


Highlights of his pandering included:


  1. No change to rates (or rhetoric)
  2. Setting expectations for “exceptionally low” rates for an “extended period” of time
  3. Extending the MBS/Agency program to the end of Q1 2010


Don’t get upset with this. Deal with it.


At $75.86, the US Dollar Index is now making fresh YTD lows. At the same time, the associated REFLATION with a Burning Buck has the US stock market making fresh YTD highs. The Pain Trade in anything priced in US Dollars remains UP.


This is an “exceptionally low” point for the once vaunted American financial system’s credibility.


I am moving my immediate term TRADE (upside) target in the SP500 to 1085.



Keith R. McCullough
Chief Executive Officer


Game Time Call: Bernanke Burns The Buck... - berngeit


AZO: In the Repurchase Zone

Putting the fundamentals and a slight Street miss aside, how could we not zero in on the irony of the repurchase activity? AutoZone continued its aggressive share buyback during its fiscal fourth quarter and for the full year.  Over the course of the quarter, the company repurchased 3.8 million shares at a cost of $587 million.  For the year the tally was 9.3 million shares at a cost of $1.3 billion, leaving total shares outstanding down 15% year over year.  Of course, aggressive share repurchase is nothing new for AZO, nor is using leverage to fund such purchases. 


Over the same time, the company’s largest shareholder, ESL Investments, disposed 3.78 million shares of its holdings on the open market.  Now we know Eddie Lampert did resign from his position on the board, but the relationship between the company and its largest shareholder obviously remains tight.  With ESL’s sales offset by AZO’s purchases, ESL reduces its ownership stake by 5% after taking in almost $600 million in proceeds. 



AZO: In the Repurchase Zone - 1



Sports Apparel: Negative Datapoint

Sports apparel numbers (as reported today by SportscanINFO) slowed for the third consecutive week, reversing an otherwise encouraging trend since August. Weekly ebbs and flows in this data is routine, but we start to pay attention to three consecutive data points. What’s most intriguing is that the sports retail channel remains very solid – as is the family channel, but is weakness in mass channels that took down the average yet again.



Sports Apparel: Negative Datapoint  - 1


Sports Apparel: Negative Datapoint  - 2


Sports Apparel: Negative Datapoint  - 3




At Research Edge, black books provide an in-depth look at our strongest fundamental ideas.  I have recently completed a black book on BWLD.  This black book looks at the company from both a fundamental and macro (Keith McCullough) perspective.  Please email me if you would like a copy.


BWLD - BLACK BOOK - BWLD black book



KM just shorted MCD again as the stock broke through his $56.37 TREND line.


On the positive side, the stock dividend yields 3.5% and management will likely raise the dividend again in December.  The company reassesses its dividend policy once a year.  The company will generate over $1.0 billion in FCF (after dividends and capital spending), spending most of it on share repurchase.  Valuation is reasonable, trading at 8.5X NTM EV/EBITDA.  Lastly, the dollar headwind will become a tailwind in 4Q09.  What’s not to like?


I have no problem being short MCD because sales are slowing and it was the only restaurant company on the planet not to see a big benefit from lower food costs in 2009.  The company will report 3Q earnings on October 22 and is holding its bi-annual analyst meeting in mid November.  Given the severity of the decline in same-store sales, management will likely be on the defensive as it relates to the launch of McCafe – the most expensive new product launch in the company’s history.


From day one, I have contended that this McCafe launch was never going to work because it falls outside of the company’s core competency and does not appeal to McDonald’s core customer.  While I thought the product would have some success during the initial launch period, given McDonald’s marketing muscle, even that has not played out.  The continued slowdown in the U.S. highlights that MCD’s espresso-based beverage platform is still not working.  Additionally, as I have said before, the fact that MCD has said recently that breakfast sales are declining increases my conviction that MCD’s specialty beverage launch will not prove to be the success that investors have anticipated for some time.  If the company cannot drive incrementally more specialty beverage sales during the initial months of its national campaign (while offering giveaways) and in the summer months, it will become significantly more difficult going forward.


We will be interested to hear from management more specific, measurable performance metrics on the launch.  Specifically, how many McCafe units are the restaurants selling per day relative to the targeted 100 units and what level of incremental sales is being generated relative to the planned $125K per restaurant from the entire beverage rollout.  For reference, the company sold about 45-50 McCafe beverages per day in test markets, a level that some franchisees thought was too low to warrant a national rollout.


I’m going to go out on a limb and make up an excuse for MCD executives before they do.  Initially, management contended that it needed to get on national TV for the McCafe product to hit full stride.  Now, MCD is on TV and it’s still not working.  Management will need a new excuse because it is not going to admit defeat just yet.  The NEW excuse will be that that the company needs to get the full line of beverages in place before the consumer will be fully aware of all the new beverage products the company is trying to sell. 



Also, the all important ROIIC metric that I talk about so often is in a free fall!



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