Red Light Risk

“As investors, we can’t change the course of events, but we can attempt to protect capital in the face of foreseeable risks.”

-David Einhorn

 

Admittedly, when “bottom’s up” hedge fund manager David Einhorn proclaimed his new macro mystery of investing faith at the ‘Value Investing Congress’ on October 19, 2009, I was smiling. Our Hedgeyes call this proactively managing macro risk and I do support Mr. Einhorn’s message.

 

Einhorn and I are about the same age. We both grew up in a hedge fund bubble. For a decade, we were probably both overpaid. He still runs money and I run my mouth, so I am thinking that he’s probably worth a lot more than me. But what does that mean?

 

To some in this business, that means a lot. To others, it means nothing at all. We all wake up early every morning with a passion to play this game. David’s Greenlight Capital now has its macro views. I have mine. Game on.

 

The global macro risk manager’s job in this business is to acknowledge amber flashing lights, before they go red. It’s also being keenly aware of when one of your big “ideas” is everyone else’s too. Measuring consensus is part of any repeatable Red Light Risk Management process.

 

Embedded in our macro risk management process are 3 dominating Global Macro Themes. We change them quarterly, because the math changes daily. As a reminder, my team’s current Macro Themes for Q1 of 2010 are:

 

1.       Buck Breakout (bullish on the US Dollar; bearish on gold)

2.       Rate Run-up (bearish on government bonds)

3.       Chinese Ox In A Box (bearish on Chinese equities; bullish on Chinese currency)

 

I do not know what Einhorn thinks on Macro Themes 2 and 3 but, now that he does macro, he obviously better have a view. That said, I do know that he stands on the other side of me with regards to both the US Dollar and Gold.

 

In that same speech, Einhorn made the following conclusions about gold:

 

1.       “Of course, gold should do very well if there is a sovereign debt default or currency crisis.”

2.       “I subscribed to Warren Buffett’s old criticism that gold just sits there with no yield and viewed gold’s long term value as difficult to assess.”

3.       “Gold does well when monetary and fiscal policies are poor and does poorly when they are sensible.”

 

After being bullish on gold since 2003, and vehemently bearish on what I labeled the “Burning Buck” in early 2009, I do think I have the credibility associated with understanding the bearish dollar/bullish gold case. There are many aspects to Einhorn’s conclusions that I agree with, but not at every price and every duration.

 

Now, if you really want to manage Red Light Risk in global macro, you better manage those two things dynamically  - price and duration. I have written about this before, but it’s worth mentioning again. Duration Mismatch is one of the top 3 risks that has hurt me over the course of my risk management career. We need to monitor it systematically and measure it scientifically.

 

Back to Einhorn’s points on gold. On an immediate (TRADE) to intermediate term (TREND) duration (3 weeks to 3 months), gold has not done well in the face of sovereign debt default risks rising. Now maybe he meant a sovereign debt default crisis in the USA and, to be fair, we should give him the benefit of the doubt until he replies to this. But, so far, with CDS (credit default swaps) in Greece blowing out to 414 basis points last night, gold is still going down.

 

Gold is going down because I am right on the Buck Breakout. Yes, as Mr. Buffet pointed out to David way back when, there are many risks embedded in evaluating the gold price. But those difficulties work both ways! Today, in terms of measuring the risks of being long gold, the r-square is highest relative to up moves in the US Dollar.

 

Managing Red Light Risk is just that. You have to accept that there are many types of investors telling many different types of qualitative stories about what it is that they are bullish on. You also have to accept that Mr. Macro Market’s math will rule the day over all the storytelling.

 

This morning the US Dollar is making a 5 month-high at $78.94. Gold is trading down another -1% for the week to-date at $1083/oz. I am long the US Dollar and short Gold via the UUP and GLD etfs, respectively, and I have a zero percent allocation in our Asset Allocation Model to Commodities.

 

The long term TAIL of resistance for the US Dollar Index is up at $80.21, and I think it’s going to test that line this year. My long term TAIL line of support for the gold price is down at $997/oz. That’s another -8% of Red Light “foreseeable risk” that these Hedgeyes are calling out for you Mr. Einhorn. Welcome to the game of proactively managing macro risk. It’s a full contact sport.

 

Best of luck out there today,

KM

 

LONG ETFS

 

XLV – SPDR Healthcare — We bought back our bullish intermediate term view on Healthcare on 1/22/10.

 

EWC – iShares Canada — We remain bullish on the intermediate term TREND for Canada. With a pullback in the ETF, we bought Canada on 1/15/10 and 1/21/10.

 

XLK – SPDR Technology — We bought back Tech after a healthy 2-day pullback on 1/7/10.

 

UUP – PowerShares US Dollar Index Fund — We bought the USD Fund on 1/4/10 as an explicit way to represent our Q1 2010 Macro Theme that we have labeled Buck Breakout (we were bearish on the USD in ’09).

 

EWG - iShares Germany —Buying back the bullish intermediate term TREND thesis Matt Hedrick maintains on Germany. We are short Russia and, from a European exposure perspective, like being long the lower beta DAX against the higher beta RTSI as well.


EWZ - iShares Brazil — As Greece and Dubai were blowing up, we took our Asset Allocation on International Equities to zero.  On 12/8/09 we started buying back exposure via our favorite country, Brazil, with the etf trading down on the day. We remain bullish on Brazil's commodity complex and believe the country's management of its interest rate policy has promoted stimulus.

CYB - WisdomTree Dreyfus Chinese Yuan — The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.

TIP - iShares TIPS — The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield. We believe that future inflation expectations are mispriced and that TIPS are a efficient way to own yield on an inflation protected basis.

 
SHORT ETFS

 

GLD – SPDR Gold SharesWe re-shorted Gold on a bounce on 1/25/10. We remain bullish on the US Dollar and bearish on the intermediate term TREND for the gold price as a result.

 

IEF – iShares 7-10 Year Treasury One of our Macro Themes for Q1 of 2010 is "Rate Run-up". Our bearish view on US Treasuries is implied.
 
RSX – Market Vectors Russia
We shorted Russia on 12/18/09 after a terrible unemployment report and an intermediate term TREND view of oil’s price that’s bearish.

 

EWJ - iShares Japan While a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership  appears, if anything, to have a less developed recovery plan than their predecessors. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands


Did the US Economy Just “Collapse”? "Worst Personal Spending Since 2009"?

This is a brief note written by Hedgeye U.S. Macro analyst Christian Drake on 4/28 dispelling media reporting that “US GDP collapses to 0.7%, the lowest number in three years with the worst personal spending since 2009.”

read more

7 Tweets Summing Up What You Need to Know About Today's GDP Report

"There's a tremendous opportunity to educate people in our profession on how GDP is stated and projected," Hedgeye CEO Keith McCullough wrote today. Here's everything you need to know about today's GDP report.

read more

Cartoon of the Day: Crash Test Bear

In the past six months, U.S. stock indices are up between +12% and +18%.

read more

GOLD: A Deep Dive on What’s Next with a Top Commodities Strategist

“If you saved in gold over the past 20 to 25 years rather than any currency anywhere in the world, gold has outperformed all these currencies,” says Stefan Wieler, Vice President of Goldmoney in this edition of Real Conversations.

read more

Exact Sciences Up +24% This Week... What's Next? | $EXAS

We remain long Exact Sciences in the Hedgeye Healthcare Position Monitor.

read more

Inside the Atlanta Fed's Flawed GDP Tracker

"The Atlanta Fed’s GDPNowcast model, while useful at amalgamating investor consensus on one singular GDP estimate for any given quarter, is certainly not the end-all-be-all of forecasting U.S. GDP," writes Hedgeye Senior Macro analyst Darius Dale.

read more

Cartoon of the Day: Acrophobia

"Most people who are making a ton of money right now are focused on growth companies seeing accelerations," Hedgeye CEO Keith McCullough wrote in today's Early Look. "That’s what happens in Quad 1."

read more

People's Bank of China Spins China’s Bad-Loan Data

PBoC Deputy Governor Yi says China's non-performing loan problem has “pretty much stabilized." "Yi is spinning. China’s bad-debt problem remains serious," write Benn Steil and Emma Smith, Council on Foreign Relations.

read more

UnderArmour: 'I Am Much More Bearish Than I Was 3 Hours Ago'

“The consumer has a short memory.” Yes, Plank actually said this," writes Hedgeye Retail analyst Brian McGough. "Last time I heard such arrogance was Ron Johnson."

read more

Buffalo Wild Wings: Complacency & Lack of Leadership (by Howard Penney)

"Buffalo Wild Wings has been plagued by complacency and a continued lack of adequate leadership," writes Hedgeye Restaurants analyst Howard Penney.

read more

Todd Jordan on Las Vegas Sands Earnings

"The quarter actually beat lowered expectations. Overall, the mass segment performed well although base mass lagging is a concern," writes Hedgeye Gaming, Lodging & Leisure analyst Todd Jordan on Las Vegas Sands.

read more

An Update on Defense Spending by Lt. Gen Emo Gardner

"Congress' FY17 omnibus appropriation will fully fund the Pentagon's original budget request plus $15B of its $30B supplemental request," writes Hedgeye Potomac Defense Policy analyst Lt. Gen Emerson "Emo" Gardner USMC Ret.

read more