Golden Headfakes

“Money is gold, and nothing else.”

-J.P. Morgan


That was one of John Pierpont Morgan’s summary investment conclusions before he passed away in March of 1913.


Ironically enough, later that year, Carter Glass introduced modern day central planning of market expectations, currency manipulation, etc. to the US House of Representatives via the Federal Reserve Act.


By 1971, when US Dollar denominated money was fully politicized by Nixon (he outright abandoned the Gold Standard), J.P. must have been rolling in his grave…


Today, I’d say that money is whatever you think you have that can pay for things. In other words, if all your money was denominated in Bitcoins, Burning Yens, or Russian Rubles, you can pay for a lot less today than you could last year.


Money can often be an illusion of wealth, and nothing else.

Golden Headfakes - Dollar cartoon 11.25.2014


Back to the Global Macro Grind


What if all your money was in the Russell 2000 this year? That would suck. After doing literally nothing (flat for 4 straight weeks in November), the Russell #Bubble got pounded for a -1.7% loss yesterday, falling back to -0.9% for 2014 YTD.


Gold, on the other hand, had a big day, rallying +3.1%, inching its way back to +0.8% for 2014. And this came on a US Dollar DOWN day, which drove the machines squirrely.


*Squirrely (definition: to chase one, either proverbially in your head, or physically in the Yale Hockey House).


Here are the inverse correlations, across durations, between Gold and the US Dollar Index:


  1. 180-days = -0.90
  2. 120-days = -0.94
  3. 90-days = -0.96


In other words, for most of the time in the last 3-6 months, Gold has been the inverse of the US Dollar, and nothing else.


“So”, with the following moves across a crashing commodity complex yesterday:


  1. Silver +6.1% to -15.0% YTD
  2. Wheat +5.1% to +0.3% YTD
  3. WTI Crude Oil +4.8% to -29.5% YTD


What do you do? Do you chase the squirrel? Do you fade? Or do you do nothing at all?


Most of the time, I like to analyze everything… and do nothing. It hasn’t always been this way for me (as a knuckle-head hockey player, I always thought I needed to do something!). But as I age, I’ve found that there is more money in waiting and watching.


After not chasing silver, wheat, or oil yesterday, and seeing today’s renewed selling in everything inflation expectations (commodities down), I’ll be considering the short side of Gold and Silver today.


While we can have a healthy debate about the definition of squirrel hunters or money, there is none to be had about the direction of trending prices – they are either inflating or deflating – and it’s our job to be on the right side of those trends.


As of this morning’s refreshed price, volume, and volatility data here are some bearish Hedgeye TRENDs I want to reiterate:


  1. Russell 2000 remains bearish TREND with intermediate-term resistance = 1190
  2. UST 10yr Bond Yield remains bearish TREND with intermediate-term resistance = 2.79%
  3. CRB Commodities Index remains bearish TREND with intermediate-term resistance = 280
  4. Gold remains bearish TREND with intermediate-term resistance = 1225
  5. Silver remains bearish TREND with intermediate-term resistance = 17.98
  6. WTI Oil remains bearish TREND with intermediate-term resistance = 85.31


I know, I know… but the SP500 and Apple are up. And that’s just great – but it doesn’t change the fact that the stability of the macro market’s proverbial snow-pack is getting less stable by the day.


Exercising the same mountain of snow metaphor, if there is one factor forming within the layers of interconnected market risk that is signaling #avalanche right now … it’s #deflation.


In between now and mid-December you have two causal forces (Draghi/ECB perpetuating #deflation via devaluing the Euro and/or a Japanese snap election that will decide at what pace Abe/Kuroda can burn the Yen) that can drive #StrongDollar deflation.


If yesterday was simply a head-fake, and Dollar Up, Gold Down, Oil Down correlation risks take hold (again), the accumulation of #deflation risks will continue to rise. And neither Putin nor High-Yield Energy/Gold Bonds will sit on this mountain of risk idly.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.16-2.26%

SPX 2029-2077

RUT 1146-1173

VIX 13.11-15.59

USD 87.41-88.54
WTI Oil 64.45-69.69
Gold 1154-1225


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Golden Headfakes - 12.02.14 Chart

November Rain

This note was originally published at 8am on November 18, 2014 for Hedgeye subscribers.

“If at first you don’t succeed, then skydiving definitely isn’t for you”

- Steven Wright


Every November for the last decade, my high school buddies and I gather ahead of Thanksgiving to toast our respective, eclectic journeys into grown up’ness.


Every November for the last half-decade, domestic inflation expectations have crashed in an acute, seasonal de-crescendo.                                                                                                                                                    

Every November, Global Central Bankers meet in the collective effort to arrest economic gravity. 


Every December, the Macro Muchachos of Hedgeye toast to the profit opportunities borne of the unique pervasiveness of this-time-is-different’ness


Back to the Global Macro Grind…


In mid-October, Fed researchers documented Residual Seasonality in the reported Inflation data whereby in 8 of the last 10 years consumer price inflation has tended to be higher in the first half of the year than in the second half – a pattern evident even in the seasonally adjusted data. 


The research doesn’t really offer a supporting theory for the serial seasonality but the publication of the research suggests the Fed is, at least, aware of the seasonality and may (partially) discount the magnitude of sub-target inflation reported in the 3rd and 4th quarters. 


Notably, the paper also fails to identify policy itself as a contributing factor in perpetuating that phenomenon. 


As can be seen in the 1st Chart of the Day below, policy initiatives have, in recurrent fashion, been implemented circa November in the wake of crashing growth expectations.  


November Rain - EL Chart  1 QE vs BE


The direction of causality is (perhaps) open to debate but given that QE initiatives (generally announced in late 3Q) drove recurrent bouts of commodity price inflation & ‘escape velocity’ optimism into the New Year and that inflation expectations, in regular fashion, collapsed subsequent to cessation of QE initiatives is certainly suggestive.   


The 2nd chart of the day, first published by our Financials team early in the year, shows that the end of QE1 & QE2 were both followed by sharp drops in 10-year treasury yields as the bond market priced in slowing growth and the inability of the private sector to successfully take the hand-off from the Fed.   We’re inclined to interpret the current weakness in the 10Y as a protracted version of this recurrent cycle.  Essentially, it's the same selloff seen in the last two iterations, but in slow-motion, over the duration of the taper instead of all at once.


The Fed wants to get out of QE if only to afford themselves the opportunity to get back in and the cost-benefit balance in terms of policy spillover to financial market (in)stability has shifted in favor of policy normalization, but established patterns/habits and embedded (dovish) ideologies are hard to break…. particularly with the Quad#4 scourge of disinflation and slowing growth becoming an increasingly tangible threat.    


In physics, Constructive Interference describes the phenomenon of wave propagation and the propensity for two, in-phase waves to meet and produce a resultant wave larger in magnitude than either of the individual waves.  Conversely, destructive interference, describes the propensity for two, out of phase waves to cancel each other out. 


How does that relate to global macro risk? 


A host of individual economies have traversed through Quad #4 over the last 5 years.  However, the preponderance of G7/G20 economies have been at different points along the economic cycle at any given time – effectively in a state of destructive interference with the collective effect being a global economy oscillating above and below middling growth.


One benefit from being “out-of-phase” is that a rotate-the-QE model among DM central banks was a viable strategy and the race to the currency war bottom could proceed in a more-or-less orderly fashion.   


At present, however, the global Macroeconomy is experiencing a constructive interference of sorts whereby individual country cycles are converging to an in-phase wave of disinflation and decelerating growth.  The expedited collapse in major currencies and the discrete rise of $USD correlation risk is symptomatic. 


Growth, domestically, was almost 5% in 2Q. The first  revision to 3Q GDP will  show a negative revision down to  ~3%.  The early estimate for 4Q from the Fed’s GDPNow model is pointing to  +2.6% growth.   


The U.S. has been a source of relative strength but the late-cycle data is cresting alongside persistent, negative revisions to global growth and inflation estimates.  With bonds leading asset class performance YTD and the canonical defensive trio of XLV/U/P leading the 2014 rise in sector variance, the market has been discounting some measure of the current reality for some time. 


Personally, I’m getting bored of being long the long bond and would welcome a shift back into early-cycle, high growth/high beta exposure but neither the quant nor the fundamental data are supportive of that, yet. 


In other physics 101 news, Work still = Force x Distance.  


Here, distance actually refers to displacement, so, if your net change in position is zero you didn’t technically do any work.  On a physics score, the Russell 2000, having round-tripped in price, hasn’t done any work for two weeks….technically, with the S&P 500 up ~0% on an inflation adjusted basis since mid-2000, we haven’t done any work in nearly two decades. 


Yup…all the collective speculation, all the sunken search and research costs, all the spurious activity = zero work done when measured in SPX price terms.    

To Tuesday morning existentialism and bull markets in (economic) #gravity. 


Our immediate-term Global Macro Risk Ranges are now:  


UST 10yr yield 2.29-2.35%

RUT 1149-1181

CAC40 4149-4262

VIX 12.53-16.01

Yen 114.04-116.94

WTI Oil 74.05-76.99

Gold 1130-1203 


Christian B. Drake

U.S. Macro Analyst


November Rain - EL Chart  2 QE vs BS


*Long YUM Call Today @10AM

Call Details:

Toll Free Number:

Direct Dial Number:

Conference Code: 968989#

Materials: CLICK HERE


*Long YUM Call Today @10AM - 1



  1. Vulnerable to Activism  There has been a number of events over the past two years that suggest the timing is optimal for YUM to simplify its corporate structure.  While there several different avenues of value creation, one thing is clear: YUM’s new corporate structure, multiple brands and underleveraged balance sheet almost ensure that the company is vulnerable to change.  What remains to be seen, however, is if the new CEO will be proactive and effect change or be reactive to the changing marketplace.
  2. Transformational Transaction  For the better part of the past two years, management has been asked about a potential spinoff of the China business.  In our view, this move would be the first step in a series of potential transactions that would simplify the structure and improve the operating performance of the company.  We find it likely that a group of influential shareholders begin to push the board in this direction.  It also makes sense to consider spinning off the dilutive Pizza Hut (co-owned stores) business, which would trade at a substantially higher multiple as a standalone entity.
  3. Multiple Ways to Win The new global reporting structure of the company allows for a clean split of YUM's business units into multiple asset-light business models.  We also believe there is an opportunity to increase leverage (to repurchase stock or pay a special dividend), cut excess SG&A, refranchise additional restaurants and command a premium valuation. 


Howard Penney

Managing Director


Fred Masotta


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 80.43%
  • SHORT SIGNALS 78.35%

CAT: E&T As The New RI, And Retrieving Your Excavator From Botswana

“Again, we get down to low $70s, a lot of bets are going to change on a lot of things. And there's no doubt that would be impacted to some degree. I would agree with that.”

– Doug Oberhelman 3Q 2014 Earnings Call





We have long referred to CAT as exposed to ‘resources-related capital spending’, not just mining, because we have expected a decline in energy-related capital spending.  Given the decline in crude oil prices, it seems likely that CAT’s 2015 will show stress from reduced oil & gas capital spending.  CAT’s Energy & Transportation (E&T) segment was already facing 2015 challenges from Tier IV Final. 


We also expect 2015 to bring some credit challenges to CAT Financial.  With the further declines in mined commodities, as well as Mercury Air Toxics regulations, receivables backed by mining equipment collateral may be less secure than some investors expect.  Higher provisions for credit losses seem likely, as mining equipment values (and liquidity) are likely to decline just when collateral value matters most.  CAT has had some “material weaknesses” relating to its Allowance for credit losses, but the allowance magnitude looks like a pressing problem.


We view 2015 consensus as too high, with our expected range in the $4.50-$6.70 reasonable range for next year (an EPS decline) vs. a consensus $7.05, ex charges.  There is a meaningful upcoming catalyst in the initial 2015 EPS guide with CAT’s 4Q earnings report in January.


*See Sept 2012 CAT 10 minute thesis call here, slides: CAT's Deep Cycle or our March 2013 Mining & Construction Equipment presentation for a full review.  We also held a call with the former head of Finning Power Systems titled Understanding CAT Power Systems.  On excess capital investment in energy, see links here.


Oil & Gas Capital Spending


The shale boom and high energy prices significantly increased capital investment in crude oil and natural gas production.  This chart ends in 2013, but conveys the idea reasonably well.  In our view, there is significant potential downside to oil and gas capital investment.


CAT: E&T As The New RI, And Retrieving Your Excavator From Botswana - cta1



CAT sells large engines and turbines into oil & gas applications, with much of the equipment fetching high margins.  The list below is from a call with Jeff Leigh, former head of Finning Power Systems.


CAT: E&T As The New RI, And Retrieving Your Excavator From Botswana - cta2



CAT in the Last Energy Downturn


Looking at CAT’s 1983 annual report, it is interesting to note that lower oil prices caused a meaningful drop in turbine and engine shipments, among other difficulties, particularly in emerging markets.  We have often compared the current resources capital spending downturn to that of the 1980s (see Party Like Its 1979).  Truck engines, which benefited from lower oil and deregulation, will not be an offset for CAT in this cycle.


CAT: E&T As The New RI, And Retrieving Your Excavator From Botswana - cta3


CAT: E&T As The New RI, And Retrieving Your Excavator From Botswana - cta4



Large Gensets & Locomotives:  2015 Tier 4 Final


Power generation is divided between prime power and standby power.  Lucrative prime power sales are often made to off-grid users, like mine sites and shale oil plays, or in emerging markets.  We assume sophisticated purchasers of larger gensets are pre-buying ahead of Tier 4 Final in 2015.  A prebuy seems evident from CAT’s E&T results, as sales are likely increasing in a pull forward from 2015.  


CAT: E&T As The New RI, And Retrieving Your Excavator From Botswana - cta5


Locomotive sales have been more formally disclosed as a T4F pre-buy, but management suggested the post-pre-buy bust will only trim about 2% off of E&T next year.  Given our understanding that something like 70% of CATs locomotive sales are in the U.S., maybe half of that is OE, and that EMD will make up a bit over 10% of E&T sales this year, the decline will be a bit larger, we think.


Taking the guided 2% decline for locomotives and what is likely to be lower genset sales post-Tier 4 Final and lower resources spending, it is not easy for to see how E&T revenues can increase in 2015. 


Gas Compression


CAT often describes natural gas compression as the “majority” of the oil & gas exposure in the Energy & Transportation segment.  It is not entirely clear if that is of sales or installed base, but it would be very helpful if they simply provided the numbers instead of leaving investors to speculate.  We assume that if it were favorable, it would be presented more clearly. 


Still, USA Compression (USAC) is the second largest outsourced compression services provider in the US, and they appear to have been fairly aggressive in 2014.  Street capex forecasts for Exterran, the largest provider, and USAC capital spending currently project a 6% and 20% decline in 2015 capital spending, respectively.  While it is challenging to get insight into the broader compression market, it does not appear to us that gas compression will drive E&T growth in 2015.


CAT: E&T As The New RI, And Retrieving Your Excavator From Botswana - cta6



Caterpillar Financial: Investors Have Yet To Scrutinize This


Is CAT paying more attention to collateral value and equipment sales than to the creditworthiness of its counterparties?  As a manufacturer, providing favorable customer financing to sell more equipment is a common pitfall.  In addition, we see a lack of diversification in CAT Financials credit exposure, since much of it appears mining-related.  If miners start to (or rather, continue to) go bust in coal, iron ore and the like, CAT may be left with mining equipment collateral that is challenging to remarket at assumed valuations.  

Note:  “Mining” as defined in Caterpillar Financial’s filings include only large miners, not all mining exposure.



Despite lending to some really interesting characters (see below) the allowance for loan losses seems low to us, both in absolute level and relative to historical norms.  While Caterpillar Financial is not a big part of CAT’s earnings, Industrials investors usually react poorly to unexpected losses at financial subsidiaries.  They often view it as having fluffed up prior equipment sales.  Remarketed used equipment can compete with new equipment sales at the same time that credit becomes less available for new equipment sales.


CAT: E&T As The New RI, And Retrieving Your Excavator From Botswana - cta7



As we understand it, portions of the deals below typically remain on CAT’s balance sheet.  Financing is often provided in pre-production (project finance), increasing the risk, as we see it.  CAT should provide more disclosure, we think. Discovery Metals’ Boseto project, a Botswana copper mine with $2.86/lb cash costs, sounds like a tough credit to us.


CAT: E&T As The New RI, And Retrieving Your Excavator From Botswana - cta8


CAT: E&T As The New RI, And Retrieving Your Excavator From Botswana - cta9


And, financing can be greater than CAT equipment value…


CAT: E&T As The New RI, And Retrieving Your Excavator From Botswana - cta10




2015 Expectations


We do not think that E&T will generate organic sales growth or a profit gain in 2015, given an anticipated decline in oil & gas capital investment and impact of Tier 4 Final.  We could, of course, be wrong, but we take the lead-off quote on the oil price as an indication of trouble ahead.  Mined commodity prices are meaningfully lower as we head into 2015, and we expect pricing pressure to intensify in mining equipment and MATS regulations to hurt coal mining.  Construction Industries should do well, but faces very tough margin comps in 1H 2015.  CAT Financial also looks challenged amid lower mined minerals prices.


If we were to pencil out a really favorable scenario for 2015, we would suggest E&T revenue flat at a margin comparable to 2014, and the same for Resource Industries.  We could grow Construction Industries at a mid-single digit rate and repeat the 2014 record margins.  We could grow Caterpillar Financial operating income by a low single digit percentage, too.  Even in that highly optimistic scenario, which is unlikely given the set-up outlined above, we would model a 2015 EPS (with buybacks) at around $6.70, below the $7.05 consensus.  In a more base-case outlook, we wouldn’t be surprised to see CAT at <$6.00 per share.





We don’t see Caterpillar escaping the downcycle in resources capital spending, with the long-awaited decline in energy capital spending now at hand.  The outlook for mining has deteriorated, with dealers inventories unlikely to make up the difference.  Increasingly, it seems investors are recognizing that the Caterpillar dealer network receives much of the service revenue.  We also expect price declines in various mined commodities to start to pressure Caterpillar Financial.  We suspect most investors have not scrutinized that subsidiary closely, yet.  


Cartoon of the Day: A Christmas Wish...

Cartoon of the Day: A Christmas Wish... - Retail cartoon 12.01.2014


The initial data points from Black Friday weekend? Not good. 

China: Why Did the PBoC Cut? (Will It Even Matter?)

Takeaway: The PBoC’s surprise rate cut confirms our bearish thesis on the Chinese economy, but may portend brighter days ahead.

Editor's note: This was originally published November 21, 2014 at 13:26 in Macro. To learn more about becoming an individual subscriber click here.

Chartreuse and Spoos: The Global Central Planning Spree Continues

As you can probably tell by the overnight action in the spoos, a central bank in Asia eased monetary policy. This time, it was China – i.e. the economy responsible for 16% of global GDP and 30% of global GDP growth (on a PPP basis). Yes, the same China where 2014 Real GDP growth is tracking at the slowest pace since 1990!


From a forward-looking perspective, this is a good thing only if it signals a sustained move away from the “proactive fiscal policy and prudent monetary policy” they’ve been guiding to and implementing for over two years now. Recall that amid incessant cries for Western-style monetary easing, the PBoC has refrained from cutting interest rates since July of 2012 (excluding the removal of the lending rate floor). It has not [broadly] lowered RRRs since May of 2012.


China: Why Did the PBoC Cut? (Will It Even Matter?) - DD1


In and of itself, this rate cut will hardly do anything to arrest the rate of decline in Chinese economic growth; nor will it offset the “increasing downward pressure” upon the Chinese economy over the NTM, as most recently reiterated Xu Shaoshi (head of the National Development and Reform Commission) just two days ago.


Chinese growth is effectively crashing at this point. Our model points to a continued slowdown of Real GDP to +7.1% YoY in 4Q – and that’s being polite (i.e. conceding their made-up numbers). The reality is that Chinese growth is far shy of that number, making the 2nd derivative impact much more severe for economies and businesses that rely on Chinese demand. Pull up a 2Y chart of Standard Chartered (STAN) if you want the real story on Chinese growth. 


So Why Cut Now?

There are two primary reasons why the PBoC surprised everyone by cutting rates today (-25bps on the benchmark household deposit rate; -40bps on the benchmark lending rate):


  • Economic growth – which had already been slowing precipitously, as evidenced by the sea of red in the table below – fell off a cliff in October. This is most easily confirmed by the rate of change in Total Social Financing growth and Macau’s mass business, which was down -8% YoY (from +15% in September). That was the first annual decline in mass revenues in over five years!
  • Amid increasingly large capital outflows (see: declining FX reserves and negative “hot money” flows) and trending disinflation, the real cost of 1Y capital in the Chinese banking system has actually risen to fairly high level of late, rising to roughly 1.4% from ~0% at the start of the year.


China: Why Did the PBoC Cut? (Will It Even Matter?) - CHINA High Frequency GIP Data Monitor


China: Why Did the PBoC Cut? (Will It Even Matter?) - China Iron Ore  Rebar and Coal YoY vs. GDP


China: Why Did the PBoC Cut? (Will It Even Matter?) - China Real Interest Rate


Again, the PBoC’s decision to cut rates today makes a ton of sense to us, given China’s sustained #Quad4 setup, which calls for a dovish response from fiscal and monetary policymakers. We just didn’t see it coming given their official guidance; it's worth noting that Beijing is notorious for sticking to the script.


China: Why Did the PBoC Cut? (Will It Even Matter?) - CHINA


Cyclical Outlook: Still Very Negative, But Potentially Positive

You’ll note that in that our GIP Model has China going into #Quad1 for the first quarter. That’s primarily because of seasonality (fiscal expenditures and credit growth tend to be front-end loaded) and, obviously, very easy comps. That being said, China had these things working in its favor at the start of this year, but obviously the tightening we saw in the early part of 2014 trumped that setup (to the downside).


China: Why Did the PBoC Cut? (Will It Even Matter?) - China GDP Seasonality


A continued “recovery” in the Chinese property market – which had been truly crashing – is also supportive of any positive 2nd derivative delta for the Chinese economy in 1H15.


China: Why Did the PBoC Cut? (Will It Even Matter?) - CHINA Property Market Monitor


It’ll be interesting to see if the rebound in property development (read: fixed asset investment) is actually sustainable amid home price deflation accelerating to the downside on a trending basis. For now, it’s too early to tell; what we do know is that Chinese policymakers are very concerned about this segment of the economy and have ratcheted up support for the sector in recent months.


Investment Conclusions

All told, the PBoC’s surprise rate cut confirms our bearish thesis on the Chinese economy, but may portend brighter days ahead from a cyclical perspective.


That being said, long-term investors should NOT get involved with any “China recovery” trade that may percolate from this. China’s structural economic imbalances and official rebalancing agenda imply continued slowing over the long-term TAIL.


Feel free to ping us w/ any follow-up questions. Have a great weekend,




Darius Dale

Associate: Macro Team

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