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MANAGING COMMODITY EXPOSURE: Long For a Trade with Deflationary Risks Looming

Takeaway: The current trend in commodity strength vs. a declining U.S. dollar has legs into the FED meeting next week, but we continue to believe that global deflation and FX devaluation from abroad will pressure commodity prices over the intermediate to longer-term. See the debate below.

 

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In a recent note, Re-Visiting Conflicting Signals and Communicating the Internal Debate , we outlined some of the conflicting signals that typically encompass a TREND reversal in an asset class by taking a look at crude oil specifically. This debate is updated in two sections (BULLISH vs. BEARISH Signals) with a confluence of easily consumable charts and commentary, much of which can be applied to the broader commodities complex and all of its derivatives. Please reach out to us with any comments or questions. 

 

To be clear, the Hedgeye macro view is that the USD will continue to strengthen over the longer term.

 

Net exposure to commodities in our asset allocation model has been mythodically increased to its current 12% level in reaction to what we expect to be yet another round of downward revisions to growth and inflation expectations. Full-year growth and inflation forecasts in our GIP model remain well below both consensus and central bank estimates and the trend in the macro data remains one of deterioration. (Counting Down to Recession?)

 

To regurgitate a few of the most relevant slides from our Q2 macro themes deck, our view on the currency shapes our biases toward managing this commodity exposure (fading the speculation-fueled, exhaustive price movements within intermediate and longer-term directional biases). Aside from the longer term cycle charts below which are self-explanatory, we would ask the following question with regards to the current state of physical oil markets: How much has actually changed since the $43-handle on WTI in March?

 

MANAGING COMMODITY EXPOSURE: Long For a Trade with Deflationary Risks Looming - USD vs. Oil Prices Long Term

MANAGING COMMODITY EXPOSURE: Long For a Trade with Deflationary Risks Looming - USD in Business Cycles

MANAGING COMMODITY EXPOSURE: Long For a Trade with Deflationary Risks Looming - Commodities Lag to USD Inflection

 

Given the current set-up of relative monetary policy accommodations around the world attempting to arrest the inevitable cycle, we like GOLD and CRUDE OIL LONG side at a time and price given the divergence between Hedgeye and consensus expectations.

 

GOLD (ETF: GLD) is currently a long position in real-time alerts.  We have also been in and out of crude oil (via OIL) long side since both completed a BEARISH to BULLISH TREND reversal in the mid-May.

 

Below we outline the BULL/BEAR Debate...

 

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BULLISH Indicators:

 

1.     The FED’s addressing of the Q1 GDP bomb at next week’s FOMC meeting, along with the deteriorating trend in domestic economic data (ex. labor market) which we expect to be USD bearish near-term

 

2.    TREND in U.S. data continues to drive bullish psychology in WTI

 

  • GROWTH: The FED will be forced to address the big downward revision in Q/Q SAAR GDP for Q1 to -0.7% vs. the original print of +0.2%
  • INFLATION: CPI for April fell to -0.2% YY from -0.1% in March and comps continue to become more difficult throughout the second half of the year
  • The Hedgeye macro GIP model (GROWTH, INFLATION, POLICY) is still tracking well below both consensus and Central Bank forecasts for the full year 2015, and we expect a continued trend in downward revisions to growth and inflation to manifest once again
  • Crude production growth is decelerating alongside a recent trend in declining inventories (changes on the margin from a bombed-out consensus stance can whip around prices)

MANAGING COMMODITY EXPOSURE: Long For a Trade with Deflationary Risks Looming - GIP Model

MANAGING COMMODITY EXPOSURE: Long For a Trade with Deflationary Risks Looming - TREND in GDP Revisions

MANAGING COMMODITY EXPOSURE: Long For a Trade with Deflationary Risks Looming - TREND in Inflation Revisions

MANAGING COMMODITY EXPOSURE: Long For a Trade with Deflationary Risks Looming - Prod weighted delta

MANAGING COMMODITY EXPOSURE: Long For a Trade with Deflationary Risks Looming - DOE Delta Inventories

MANAGING COMMODITY EXPOSURE: Long For a Trade with Deflationary Risks Looming - Rig Count Chart

MANAGING COMMODITY EXPOSURE: Long For a Trade with Deflationary Risks Looming - Rig Table

 

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BEARISH Indicators:

 

1.     Consensus short bias has been washed out from the March lows in crude oil and is now chasing price higher

 

2.    On a global scale, there is still a surplus in oil, and preliminary domestic production estimates from the EIA have been upwardly revised. In effect, net of the currency move which is our most important indicator, not much has changed fundamentally since March

  • Consensus short positioning in commodities, as evidenced by the CFTC Commitments of Traders Report, is much more normalized
  • Overall expected volatility and the big divergence in downside protection has flattened out
  • Drastic contango in commodity futures curves is also flattening out
  • While showing signs of deceleration, domestic crude oil production is still touching new highs not seen in 43 years. The EIA reported a 43-Year high of 9.6MM B/D of production in May (NOTE: The EIA has upwardly revised preliminary estimates for February, March, and April production numbers which originally showed a noticeable deceleration in production starting in March (See table below)
  • A survey of oil companies from a two-time Hedgeye Guest speaker, Leonardo Maugeri, suggests most cap-ex cuts haven’t hindered projects already underway:

“I ran a test on a sample (20) of large and medium-sized oil companies, asking each one about its expectations for the future. With two exceptions, all of them answered me that they believe firmly in a short-term rebound of crude oil prices, specifically because of the investment cuts announced by everyone. The next question was: You also announced massive cuts, but have you cut investments in oil development that is underway? The answer was a flat “no.” Naturally, the final question was: Then from whom do you expect the future production cuts?

After some perplexity, the general answer I received was "from others." I could only follow up with a supplemental question: But who are the others, in detail? No one could explain it.”

  • The trend in commercial refinery inventory draws has been a psychological supporter of oil prices, but overall inventories are not far off of all-time highs (still +~20% YY)
  • Global crude production in 3 of the top 4 producing countries is up double digits YY and delta positive in 17 of the top 20 producing countries, also on a YY basis

CFTC Positioning on the March Lows in Commodity Prices vs. Current (Biggest reversal in energy).

 

CURRENT Positioning:

 

MANAGING COMMODITY EXPOSURE: Long For a Trade with Deflationary Risks Looming - CFTC Positioning Current

 

MARCH Positioning:

 

MANAGING COMMODITY EXPOSURE: Long For a Trade with Deflationary Risks Looming - CFTC Posiitoning April

 

Crude Oil Positioning Chases Price:

 

MANAGING COMMODITY EXPOSURE: Long For a Trade with Deflationary Risks Looming - CFTC Positioning in oil

MANAGING COMMODITY EXPOSURE: Long For a Trade with Deflationary Risks Looming - Positioning Vs. OPil Price

 

The following table looks at volatility skew at different points in time on spot contracts since last summer. Both the trend in volatility and negative skew have normalized since crude moved off its 2015 lows.

 

MANAGING COMMODITY EXPOSURE: Long For a Trade with Deflationary Risks Looming - Vol Skew Chart in Different Months

 

The Contango in futures markets has become much less drastic since March:

 

CURRENT 1-Yr SWAP


MANAGING COMMODITY EXPOSURE: Long For a Trade with Deflationary Risks Looming - Spot 1 Yr Spread Current

 

MARCH 1-Year SWAP

 

MANAGING COMMODITY EXPOSURE: Long For a Trade with Deflationary Risks Looming - Spot 1 Yr spread March

 

PRELIMINARY EIA ESTIMATES (BLUE SERIES) vs. revised numbers

 

MANAGING COMMODITY EXPOSURE: Long For a Trade with Deflationary Risks Looming - EIA production now vs. April

 

Aggregate commercial crude inventories not far off of all-time highs

 

MANAGING COMMODITY EXPOSURE: Long For a Trade with Deflationary Risks Looming - DOE Aggregate Inventories

 

GLOBAL PRODUCTION MONITOR

 

MANAGING COMMODITY EXPOSURE: Long For a Trade with Deflationary Risks Looming - Global Production Monitor

 

Ben Ryan 

Analyst

 



 



 

 

 

   


Call Summary and Replay: The Impact of Currency Wars on the S&P 500

Takeaway: Our Financials team hosted a call with the Accounting Observer outlining which companies are most disadvantaged from a strong dollar.

The Hedgeye Financials team hosted a conference call with the CEO of the Accounting Observer, Jack Ciesielski who has done deep dive work on the current impact of the strongly trending U.S. dollar on the constituents of the S&P 500. The replay of our call is below:

 

Call Summary and Replay: The Impact of Currency Wars on the S&P 500 - chart1

 

Launch audio replay HERE

Materials for the presentation are HERE

 

The 3 most important takeaways from the call in our view were:

 

1.) The impact of the U.S. dollar continues to increase into 2015, with the +11.3% increase in the U.S. currency in 2014 accelerating into the first quarter of this year with another +7% rally. In totality, 296 companies out of a pool of 336 companies on a December fiscal reporting schedule reported declines in cash and cash equivalents from a stronger dollar.

 

Call Summary and Replay: The Impact of Currency Wars on the S&P 500 - chart2

 

Call Summary and Replay: The Impact of Currency Wars on the S&P 500 - chart3

 

2.) Exposure is not created equal with 24 companies experiencing a greater than 7% decline in their cash balances in the first quarter of 2015 alone. Losses in cash and in equity balances are a new phenomenon over the past 6 quarters, with very little impact being felt in 2013. Bellwethers including Philip Morris, McDonald's, and Kimberly Clark have lost -19.8%, -10.9%, and -7.1% of their cash resources respectively due to currency fluctuations net of hedges thus far year-to-date.

 

Call Summary and Replay: The Impact of Currency Wars on the S&P 500 - chart4

 

3.) Industrials, Healthcare, and Financials are shouldering most of the currency load with the Energy sector not too far behind. Although, most investors think that matching revenues and expenses in foreign operations as well as financial hedging is the most effective way to manage FX risk, the Account Observer outlined that only matching foreign subsidiary equity with the consolidated parent equity balance is a way to truly nullify FX exposure.

 

Call Summary and Replay: The Impact of Currency Wars on the S&P 500 - chart5

 

Macro Team

 

 



Cartoon of the Day: Tick... Tock...

Cartoon of the Day: Tick... Tock... - Aging America cartoon 06.09.2015

 

Editor's Note: Below is one of our Macro Team's Q2 2015 macro themes. 

 

#DemographicYields: Year after year in the post-crisis era, investors, economists and policy-makers alike have consistently seen their estimates for GDP growth, inflation and interest rates surprised to the downside. Perhaps there is some merit to the “secular stagnation” thesis most recently highlighted by Bernanke’s blog. In this theme, we pull back the curtains on the impact of demographics on the domestic and global economy. The conclusion? Lower-for-longer...

 

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SJM Getting Grinded

The 4Q FY15 SJM earnings raised a lot of questions about the direction of the company. 

 

Although the company is not currently on our ideas list, we have some initial thoughts on the Q4 print and the FY16 outlook. After experiencing a challenging FY15, SJM management expects to recover in 2016, and years to follow.  At the same time the company is digesting the largest acquisition in the company’s history.  Given the flow of cost savings and commodity tailwinds, the recovery isn’t expected to occur until 2H16. They are projecting an aggressive assumption of 3% organic growth for FY16 and attributing it mainly to volume increases coming from new coffee products.

 

HEDGEYE THOUGHTS BY SEGMENT

 

COFFEE (Q4 Results: $468.6mm Net Sales, -1% growth, SOP Growth -19%)

Volume decreased 15% in Q4 and operating profits declined 19%, primarily driven by the Folger’s brand. Volume softness attributed to “customer response to higher promoted price points on shelf, competitive activity, and reduced promotional effectiveness,” said Smucker. A more compact-size line of Folger’s canisters, ability to merchandise the entire Dunkin’ Donuts line, and marketing budget increases are expected to yield overall growth. Overall, SJM’s volume of Keurig K-cups increased 2% and net sales up 20%, management is going to lean heavily on this growth to drive sales in the segment. Management anticipates that coffee will face challenges in the first quarter of FY16 as they will not benefit from lower commodity costs.  Management has high expectation for the coffee segment in FY16:

 

  1. The company will see lower green coffee costs as FY16 progresses.  Volume should benefit from lower promoted price points on the Folgers' mainstream offerings.
  2. This summer SJM will complete the conversion of the Folger’s large cans to a reduced canister size.  The cost savings will be passed along to customers and the company will benefit from increased units sold.
  3. The Dunkin' Donuts K-Cup launch.  Over time, management believes the offerings could double the current K-Cup business which is nearly $300 million in net sales in FY15.

 

HEDGEYE – The commodity tailwind is real but the Folger’s brand continues to struggle and K-Cups will likely disappoint on the top line.  It will be a challenge for the company to hit the internal target s in FY16.

 

 

CONSUMER FOODS ($427.5mm, -8%, -5%)

Jif branded peanut butter volume decreased 6% and net sales decreased 18% due to a 7% price decrease in November 2014 and promotional spending recognized in the quarter. Volume for the Pillsbury brand decreased 8% and net sales decreased 18%. Per our previous research on GIS, we have determined the dry mix dessert business is not a good one to be in. We want to give them some credit here, Smucker’s Uncrustables volume increase 21% and net sales increased 14%. Although the U.S. packaged foods environment has been a tough one for a lot of companies, SJM is lagging behind the competition.

 

HEDGEYE – There is a reason why SJM bought Big Heart Pet Brands!  SJM’s consumer food business is a collection of brands in unattractive segments of the industry.  The business will continue to be challenged in FY16.

 

PET FOOD ($239.1mm, n/a, n/a)

SJM closed the acquisition of Big Heart Pet Brands on March 23, 2015, introducing them to an entirely new category. Management is targeting synergies for FY16 of $25 million, which is extremely low considering that their three year target is $200 million. Year one goals are said to be on the conservative side by counsel of the consultant they are working with on the integration.

 

HEDGEYE - Integrating the largest acquisition in the company’s history will take time.  The company has not scaled back the synergy benefits, but the timing of the benefits have been delayed. 

 

INTERNATIONAL, FOODSERVICE, & NATURAL FOODS ($311.9mm, 6%, 10%)

The International, Foodservice, and Natural Foods segment say 10% profit growth in 4Q FY15, follow a 13% increase in 3Q FY15. For FY15 net sales and profit were flay year-over-year. In FY16, foreign currency (Canadian dollar) will be an incremental profit headwind of approximately $20 million, or $0.11 a share.  There is not incremental good news in this segment, but looking forward the business will see a higher cost of goods sold due to a significant headwind brought on by foreign currency exchange. Management anticipates growth in the segment going forward, especially with the addition of Big Heart.

 

HEDGEYE – A brighter spot, but still nothing to get excited about!

 

OVERARCHING THOUGHTS ON THE CALL

The 4Q FY15 earnings report raised more questions than it answered, and overall, SJM seemed to be playing defense throughout the call. Their outlook seems ambitious, and it is difficult to determine the feasibility of their goals given the company’s recent performance.

 

OUTLOOK

Despite a significant decline in the stock since the call, we would not be buyers.  Competition is tight and we remain skeptical that their new products will deliver on the intended growth. We’ll stay on the sidelines here and continue to monitor this situation.

 

 

 

 


CPB Chasing Growth – a little too late?

Organic consolidation continues

 

The Organic consolidation trend continued, with this latest news that CPB announced today, that it has entered into a definitive agreement to acquire Garden Fresh Gourmet for $231mm. This is now Campbell’s third acquisition in three years focused on the healthy consumer, first with Bolthouse Farms (2012), then Plum (2013) and now Garden Fresh Gourmet.

 

Campbell’s expects the transaction not to affect FY2015 as it ends on July 31, and to be slightly accretive beginning in FY2016. This continues to help extend CPB into the perimeter aisles and beyond the center-of-store.

 

In a move that has become popular amongst large traditional food manufacturers when acquiring a smaller competitor, Garden Fresh Gourmet will be operated from their HQ in Ferndale, MI. Founder and CEO Jack Aronson will stay on board as an advisor to the business.

 

This acquisition will do little to reshape the company’s struggling portfolio of brands.

 

Below is a one page summary of the Campbell’s Garden Fresh Gourmet deal: 

 

CPB Chasing Growth – a little too late? - CPB to acquire Garden Fresh Gourmet


This Sector Is Breaking Down and That’s Bad News for the Stock Market

Takeaway: Transports are breaking down and have led the losers over the past month. Not a good sign.

We guess this time is “different” with Dow Transports (IYT) not being a leading indicator for the cycle?

*  *  *  *  *  *  *

This Sector Is Breaking Down and That’s Bad News for the Stock Market - boom 06.09.15 chart

 

Leading losers from a Sector Style perspective yesterday, IYT was down -2.1% on the day versus a -0.65% decline for the S&P 500. Transports are down -4.9% month-over-month and have fallen almost -9% year-to-date.

 

The reality is that in macro strategy, there are some leading indicators that even the most creative storytellers can’t convince you that “it’s different this time.”

 

When we went bullish on US #GrowthAccelerating in 2013, the Transports index was breaking out to the upside. Now, after 73 months of this U.S. economic expansion, it’s breaking down.

 

No, that’s not a good sign.

 

Meanwhile, Global Equities look worse than the Transports! And we know one of our competitors is saying “growth is back”, but seriously – month-over-month Global Equity moves = Russia -12%, Portugal -9%, Greece -8%, Germany -7%, Brazil -7%, Turkey -7%... we’ll stop there.

 

*This is an excerpt from Hedgeye morning research. Click here for more information on our products and how you can subscribe.


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