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Takeaway: OPEC cut or not, the risk is to the upside

Before reading our expectation on the likely course of action from OPEC (we expect no action), the next few charts should be more concerning for USD Longs/commodity shorts than OPEC jawboning pre-meeting:

  1. In the first chart below, going into today, commodities have been crushed, yet protection is most expensive NOW (OVX back over 50). The market is heavily short commodities
  2. Volatility expectations for this year’s meeting are grossly higher than last year – protection is near its most expensive point since summer of 2014 (tighter stops on lower volatility expectations causes more volatility (last year’s 10%+ down day post OPEC meeting)
  3. The Commitment of Trader’s Report from the CFTC suggests the market was heavily short commodities and long dollars into this week. That doesn't get unwound in one day. A catalyst to take commodities lower from here is hard to find with renewed rate hike expectations. 

OPEC & EXPECTATIONS - Commodity positioning


OPEC & EXPECTATIONS - Implied vol in WTI




We’re seeing the risk to one-way consensus positioning front and center, as outlined in a note earlier today titled Is This the Beginning of the Great Unwind of USD Consensus Longs?

This story looks a lot like the end of August pre- Jackson Hole and rate “lift-off” expectations. You could see more of what you’re seeing today on a bad jobs report tomorrow, and this move would be exacerbated if the Fed decides to push a rate cut.  


Last year at this time the world was contemplating whether or not OPEC would conspire together in an attempt to move global energy markets. We wrote about the unlikeliness of that happening (OPEC CUT? NOPE. ) The point of the note was to dispel the relevance of OPEC quotas. It’s worth a read as a primer.

A cut was expected by many at $73 on WTI. Now, at $41, the expectation is that OPEC quotas will remain the same at 30MM B/D. For the significance of quota levels, see the chart below which shows that:

  • Out of the 48 months over the last four years that OPEC quotas have been set at 30MM B/D, OPEC collectively has produced under that quota in just 4 months (8.3% of the time)
  • Since the beginning of 2014, production has averaged more than 1MM B/D above the collective OPEC quota level
  • Any reason for production below quota levels has not been voluntary. At the end of 2013, a civil uprising reminiscent of the Libyan Revolution in 2011 was successful in reducing Libyan production by over 1MM B/D in several months (That accounted for two of the months below official OPEC quotas)
  • Of the 9 of 12 OPEC producers in the global production table below, only 2 of them has reduced production Y/Y
  • Of the 4 largest producers in OPEC, production is up double digits in all but Saudi Arabia where production is still up significantly. That’s a market share story:
    • Saudi Arabia: +8%% Y/Y
    • Iraq: +27% Y/Y
    • U.A.E.: +10% Y/Y
    • IRAN: +14% Y/Y


OPEC & EXPECTATIONS - Quota to Production Price Differential


OPEC & EXPECTATIONS - Global Crude Production Monitor


If Saudi Arabia had any plans to cut production they probably wouldn’t be racing to cut official selling prices to Asia into 2016. On a spread to the Oman/Dubai benchmark, Saudi Aramco undercut that spread in both light and heavy crude for January:




Keeping a grip on dwindling market share is the goal. In a commodity-producing business, a low-cost producer (Saudi Arabia) with the most reserves is not incentivized to cut production. OPEC’s global market share is about 36% currently, but they hold 60-70% of the world’s proven reserves.  

Like last year, Russia has already said it has no interest in complying with collective production cuts or even attending the meeting.   

Most of OPEC’s spare capacity is with Saudi Arabia. The way they see it, they are doing their job. Given any need to accommodate Iran post sanctions, it would be hard to envision lower targeted quotas unless it was purely a smoke and mirrors exercise to boost prices in the short-term. As outlined in last year’s note, OPEC ANNOUNCEMENTS have an ability to move spot prices for about 15-20 days, but there is no evidence that production levels are at all influenced.


OPEC & EXPECTATIONS - OPEC vs. Saudi Spare Capacity


OPEC & EXPECTATIONS - Saudi Spare Capacity




We think the argument the Saudi Arabia would cut production despite the fact that they are a low cost producer with endless reserves (and all of the spare capacity in OPEC) is just newsiness. FX Reserves are only down 12% from an August 2014 high, which is hardly a dent with oil prices declining 56% over that same time period. Prices could remain low for years, and they’d be in good shape.


OPEC & EXPECTATIONS - Saudi Arabia FX Reserves


Deflation has taken a hold of the market for the last 18 months, and the catalyst to reverse deflation’s dominoes will be behaviorally and policy-driven. Look for a real catalyst with tomorrow’s jobs report. A bad one could perpetuate the currency move seen today.


As always we welcome any comments or questions.


Ben Ryan


Cartoon of the Day: Look Out Whoville!

Cartoon of the Day: Look Out Whoville! - Rate hike Grinch 12.03.2015


"... Yellen was grasping for #LateCycle employment reasons to raise rates," Hedgeye CEO Keith McCullough wrote in today's Early Look. "Never mind the data – she really wants to hike."

Dear Jim Cramer, How About Kinder Morgan? | $KMI

Takeaway: Our Energy analyst Kevin Kaiser has been spot on with Kinder Morgan.

Here's what Jim Cramer had to say back in August 2014.


“It turns out we were stubborn and we were right, and Hedgeye was flippant and disrespectful and wrong. We chose to believe in Rich Kinder, and not in his critics, because we believed him when he always said his companies are "companies run by shareholders for shareholders." It looks like it wasn't worth waiting for the market to prove Hedgeye right -- because, alas, when it comes to Kinder Morgan and today's huge bid, it never, ever will be.” – Jim Cramer, “Cramer: Kinder’s Triumph,” 8/11/14


Dear Jim Cramer, How About Kinder Morgan? | $KMI - kmi kramer


Here's what Jim Cramer had to say yesterday.


“With the headwinds ahead of it, it's become seriously undervalued here at $21. And I'm recommending it, as well as buying it myself.” – Jim Cramer “Dicker/Cramer: Kinder Morgan Down 7% Today -- Now Is When You Buy,” 12/2/15


Cramer's track record speaks for itself. So does ours (see here and here).

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McCullough: ‘Buy European Equities Now? Absolutely Not’


In this brief excerpt from The Macro Show this morning, Hedgeye CEO Keith McCullough responds to two subscriber’s questions about the Euro/US Dollar exchange rate and whether to buy European equities now.


Subscribe to The Macro Show today for access to this and all other episodes. 


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Stock Report: Federated Investors (FII)

Takeaway: We added FII to Investing Ideas on the long side on 11/24.

Stock Report: Federated Investors (FII) - HE FII table 12 3 15


We think that Federated Investors (FII) is set up for upside being that its core business should experience both an increase in profitability and volume. FII is a leader in the management of money market funds, an asset class that has been out of favor for the bulk of this cycle.


However, even marginal rate hikes from the Federal Reserve would greatly improve the profitability of money funds. Secondly, cash products tend to be attractive in the latter part of the economic cycle as investors get defensive and move out of risk assets.


The company is conservatively managed with a solid balance sheet and solid free cash flow dynamics. FII pays a 3% dividend yield which ensures return on the stock as the core money fund business improves both profitability and balances.




The company has been waiving over $300 million in revenue on an annual basis for its clients to maintain a slight net positive yield on the $250 billion it manages in money fund assets. As short yields increase on the margin, the firm will recapture some of these forgone fees. The entire fee waiver opportunity is $0.50 per share in earnings and with current annual baseline earnings at $1.50 per share, this creates potentially growth of over 30%+.


There are few financial companies that are as asset sensitive as FII and, given this earnings trajectory, we think that makes the stock appealing into 2016 and 2017.




Over the past 7 years, more than $1 trillion has been redeemed in money funds and reallocated to stock and bonds, sourcing the big bull market in risk assets. With the economic cycle eclipsing 72 months, we think it is time to get defensive.


In addition to improved profitability from even marginal rate hikes, this $1 trillion becomes a longer-term opportunity for all money fund markets as investors reallocate and back out of risk assets in the latter stages of this market/economic cycle.


With roughly 9% market share in industry money fund assets, FII will recapture these funds as they come back out of stock and bond markets. We have modeled +$200 billion in positive money flow for the money fund industry in 2016 and +$400 billion for 2017. This assumption reflects some conservatism allowing for some funds to remain outside the money fund channel.


Stock Report: Federated Investors (FII) - HE FII chart 12 3 15

Draghi Disappoints… Is This the Beginning of the “Great Unwind” of Consensus USD Longs?

Takeaway: The intermediate-term outlook for the EUR/USD cross is as murky as its been in over three years.

The EUR/USD rallies, European equities plummet. Expectations were dashed around Draghi “acting” today on QE and interest rates – he lowered the deposit rate 10bps to -0.30%, kept the main interest rate unchanged at +0.05%, and extended, but importantly did not increase the €60 Billion/month QE program (now until March 2017). 


What does today’s market action mean?  Investors were holding a massive short position in the EUR/USD going into today’s announcement.  [See first CFTC chart below]. The lack of “action” caused a short covering squeeze in the EUR/USD and equities fell as the lack of “drugs” deflated the hope trade that QE raises the tide of all boats.  


Our mantra remains the same.  We maintain our macro theme of #EuropeSlowing, with our proprietary GIP (growth, inflation, policy) model signaling the Eurozone in #Quad3 (growth slowing as inflation accelerates) in the coming quarters [Second chart below].  Today the Bank’s staff revised its December GDP and CPI projections versus September – not surprising, they were revised lower!


What’s our policy outlook?  There’s an increased likelihood that the ECB has to act by expanding the size of its QE program (to €75-95B/month), likely within the first quarter of 2016, as again the Bank underperforms its growth and inflation expectations while its policy measures impart limited results on on the “real” economy. Today Draghi (with limited detail) expanded the scope of eligible regional and local debt for purchase – we expect even more leniency on what it may purchase in the coming quarters. 


Old Song and Dance. Today’s presser showed once again Draghi’s mentality to Extend&Pretend economic gravity. Draghi did not rule out that the ECB was at the lower bound of deposit range, but more importantly, when asked why the ECB chooses to cut the deposit rate, he replied:  "We simply observed that cuts improve the transmission of monetary policy". We have yet to see proof of that.


Draghi again went back to his truisms, like “The recovery is becoming broader, and driven by consumption rather than exports. Savings rate is also flat, another positive sign.”  Draghi confuses economic conditions and what may prove to be very accommodative financial conditions: we’ll certainly take the other side of his view that economic conditions are all well and good, and showing signs of improvement.


Draghi Disappoints… Is This the Beginning of the “Great Unwind” of Consensus USD Longs? - vv. CFTC


Draghi Disappoints… Is This the Beginning of the “Great Unwind” of Consensus USD Longs? - EUROZONE


EUR/USD Levels: The EUR/USD broke through our TRADE (3 weeks are less) resistance level today, yet remains comfortably below our TREND (3 weeks or more) resistance levels. One day does not a TRADE or TREND make. We maintain a bearish bias on the EUR/USD, yet much depends on U.S. data (jobs report out tomorrow) and the policy of Janet Yellen’s Fed at its December 15-16 meeting.  


Draghi Disappoints… Is This the Beginning of the “Great Unwind” of Consensus USD Longs? - vv. EUR


December ECB Staff Projections:


  • Eurozone GDP Projections foresee annual real GDP increasing by 1.5% in 2015 (vs 1.4% in Sept), 1.7% in 2016 (1.7%) and 1.9% in 2017 (1.8%)
  • Eurozone CPI Projections foresee annual inflation at 0.1% in 2015 (0.1% in Sept), 1.0% in 2016 (1.1%) and 1.6% in 2017 (1.7%)


Governing Council Decisions/Updates:


  • Maintains interest rate +0.05% and lending facility +0.30%
  • Cut deposit facility by 10 basis points to -0.30%
  • Extend asset purchase program to March 2017 (vs September 2016) or beyond if necessary – until sustain adjustment in path of inflation to achieve 2.0% target over medium term
  • Maintains €60 Billion/month program
  • Decides to reinvest principal payments of securities purchased under the asset purchase program as they mature for as long as necessary – the goal is to increase liquidity
  • Decides to include euro-denominated marketable debt instruments issued by regional and local governments in the euro area as assets eligible for regular purchases
  • Decides to continue conducting the main refinancing operations and 3-month longer-term refinancing operations as fixed rate tender procedures with full allotment for as long as necessary, and at least until the end of the last reserve maintenance period of 2017


-Matthew Hedrick, Associate


Where is the U.S. Dollar Headed From Here?

The EUR/USD cross has rallied nearly 3% today with the preponderance of the move coming on the heels of the ECB’s wet Kleenex of a policy announcement. Simply put, the market is challenging Draghi’s ability to meet lofty expectations for Eurozone monetary easing on a go-forward basis.


Obviously whenever you see a major currency cross gap up 4 big figures in a matter of hours, it’s easy to point to short covering as the primary factor. But with speculative net length in EUR futures and options contracts already having consolidated a fair amount from the perspective of our Z-Score analysis, one could make the case that today’s move is being perpetuated by a fair amount of incremental open interest on the long side. It’s worth noting that the current speculative net length of 45,977 contracts on the DXY is in the 89th percentile of all weekly readings dating back 10 years. The key takeaway here is that there’s a lot of hay to bale to the extent investors need to begin exiting crowded long-USD trades.


Draghi Disappoints… Is This the Beginning of the “Great Unwind” of Consensus USD Longs? - EXTREME SENTIMENT MONITOR


What could cause that to happen? The obvious answer is the Federal Reserve openly acknowledging the ongoing and prospective degradation in domestic economic growth that is embedded in our #LateCycle theme.


Said degradation is now painfully obvious for all to see and continues to be corroborated by high-frequency data, at the margins – most recently highlighted today by the sequentially soft November ISM Non-Manufacturing PMI reading. Specifically:


  • Various measures of household consumption growth (e.g. Real PCE, Retail Sales) are decelerating on both a sequential and trending basis;
  • Industrial production growth is decelerating on both a sequential and trending basis;
  • Export growth is decelerating on a trending basis and still contracting from a YoY perspective;
  • PMI readings are decelerating on both a sequential and trending basis;
  • Consumer confidence is decelerating on both a sequential and trending basis; and
  • Producer price inflation (a proxy for corporate revenue growth) is decelerating on both a sequential and trending basis.

Draghi Disappoints… Is This the Beginning of the “Great Unwind” of Consensus USD Longs? - ISM COMPOSITE PMI


Draghi Disappoints… Is This the Beginning of the “Great Unwind” of Consensus USD Longs? - United States Econ Summary


Draghi Disappoints… Is This the Beginning of the “Great Unwind” of Consensus USD Longs? - U.S. Economic Summary Table


Unfortunately for market participants, the FOMC remains completely out to lunch with respect to their [serially overoptimistic] economic projections and, commensurately, their “dot plot” for the Fed Funds Target Rate – both of which are completely at odds with trends across a number of relevant indicators. This disconnect makes formulating a TREND duration view on the direction of the DXY rather difficult, to say the least. Specifically, the data would imply lower-highs, but a high probability of [unwarranted] intervention by the Fed in the form of a rate hike(s) should not be ignored.


Draghi Disappoints… Is This the Beginning of the “Great Unwind” of Consensus USD Longs? - Fed FOMC Forecasting Folly


Draghi Disappoints… Is This the Beginning of the “Great Unwind” of Consensus USD Longs? - Fed FOMC Forecasting Folly  2


Draghi Disappoints… Is This the Beginning of the “Great Unwind” of Consensus USD Longs? - Hedgeye Macro G4 Monetary Policy Model


On one hand, both history and our dour cyclical outlook for the U.S. economy would support adopting a bearish bias on the U.S. dollar from here.


Draghi Disappoints… Is This the Beginning of the “Great Unwind” of Consensus USD Longs? - DXY Historical Rate Hike Analysis


Draghi Disappoints… Is This the Beginning of the “Great Unwind” of Consensus USD Longs? - UNITED STATES


On the other hand, our dour cyclical outlook for the Eurozone economy and relative distance from achieving its stated policy objectives would support adopting a bearish bias on the EUR from here. The 10Y breakeven rate in the Eurozone is a mere 1.15%, while the Bloomberg consensus estimate for Eurozone CPI in 2016 is only 1.1%; both are well shy of the ECB’s 2% target for “price stability”. This compares to 1.84% and 1.8% for the 5Y-5Y forward breakeven rate in the U.S. and the Bloomberg consensus 2016 U.S. CPI estimate, respectively. Our thought process here is that the further a given central bank is from its stated policy objectives, the higher the propensity is for it to ease at every interval – which is the ECB at the current juncture.




Draghi Disappoints… Is This the Beginning of the “Great Unwind” of Consensus USD Longs? - Eurozone Econ Summary


Given the obvious counterbalancing forces, you could make the case that the EUR/USD cross should trade in an increasingly narrow range from here. That said, however, the aforementioned positing and sentiment data would seem to suggest that the path of least resistance is actually higher for the EUR/USD – at least until  Draghi corrects today’s policy mistake with a substantially more meaningful expansion of Europe’s QE program.


A lower dollar could prove very bullish in the short term for reflation assets (energy, raw materials, EM stocks, EM FX, EM LC debt, etc.), but that is not a call we are willing to make in the absence of more data. How the Fed interprets tomorrow’s Jobs Report will be very telling on that front indeed…


-Darius Dale, Director