Sticking With Our Short on Dr. Copper

Conclusion: As the global economy slows sequentially, we expect the price of copper to decline as inventory builds and currency tailwinds unwind.


Position: Short Copper (JJC).


Refined copper imports by China (the world’s largest consumer) grew in July for the first time in four months. The 6% M/M increase reflects May and June demand for imports (it takes one to two months for the imports to arrive in Shanghai), which was high, as higher prices in Shanghai prompted arbitrage trade. A recent report out of Orient Securities Futures suggests the window for arbitrage may be closed, which is bearish for Chinese copper imports going forward.  Also, it is important to note that this important number is down -23% on a Y/Y basis.  So, while copper inventories are low in China, the culprit is really low imports rather than accelerating end market demand.


Admittedly, we were early shorting copper from a timing perspective, but we continue to have conviction on the short side – despite current low inventories. Copper stockpiles as measured by the London Metals Exchange hit the lowest levels since November 11th and are down 2.8% this month after declining 8.3% in July. Since the YTD high of 555,075 tons on February 18th, copper stockpiles on the LME have declined 27.6%. We have seen a similar decline in stocks on the Shanghai Futures Exchange, down 42% since the high of 189,441 metric tons in the week ending 4/29.


Sticking With Our Short on Dr. Copper - 1


Sticking With Our Short on Dr. Copper - 2 


Interestingly, and despite these bullish fundamentals, copper is only up 0.2% since Feb. 18th and down 1.3% since April 29th. On a two and three month basis, however, copper is up 14.1% and 11.8% respectively, which is supported by dollar weakness (the Dollar Index is down 3.1% and 2.9% over the same durations).  The fact that the price of copper has barely moved in a declining inventory environment is a bearish indicator for us as it relates to the future direction of price.


Normally, we look to the price of copper as a leading indicator for global growth, but with the mixed signals we have been receiving from a price perspective as a result of prolonged periods of dollar strength and weakness, we must turn to our outlook on global growth to forecast where we think Dr. Copper is headed. As a reminder, we are bearish on global growth in 2010 and we have a 1.7% estimate for 3Q10 and 2011 U.S. GDP growth (roughly half of consensus estimates), which is largely driven by our forecast for housing prices to fall 15-20% in the next 12 months and rising structural unemployment. In addition, we have been bearish on Chinese growth since January 15th, and with consumer price inflation hitting a 20-month high in July, we don’t expect China to loosen its tightening measures anytime soon. Additional factors supporting our bearish stance on global growth are austerity in Europe and slowing end demand from Western consumers which may serve to reduce industrial production and trade internationally.


With the looming global growth backdrop, we expect copper inventories to build, or at least see a deceleration in the rate of declines. Either result is incrementally negative for price. Furthermore, we could see dollar strength from accelerated dollar purchases by central banks globally as exporting nations from Asia to Latin America look to increase their slice of the contracting pie that is global trade in 2H10.


Managing Risk


As always, our style of investing requires a prudent risk management approach that is duration agnostic. We will continue to analyze and interpret the near-term risks to our short position in Copper. Those risks include further dollar weakness from here and reduced production in China, the world’s largest smelter of the material.


We expect tomorrow’s existing home sales to be a bomb, in the range of down 20%-30% M/M. Obviously, this will come as a shock to investors (consensus estimates are for a 12% decline), which will likely serve to conjure up more calls for increased stimulus in order to avoid a pending double dip in housing. If Bernanke and Co. give in to market pressure, we expect the dollar to resume its decline after closing up on a weekly basis for the previous two weeks. Further dollar debasement from here is positive for copper prices (r-squared = 0.69 on a two-month basis).


 Sticking With Our Short on Dr. Copper - 3


With regard to supply, the latest rumors out of China claim that the government may shut smelting plants that violate environmental rules as it looks to tighten regulation after a series of industrial accidents led to waste spilling into rivers and seas. The latest data (2008) show that China accounts for nearly one fourth of total world copper smelting output, so a reduction in production there will provide support for the price of copper. Accidents are running at an annualized rate of 204 in 1H10 compared with 171 in all of 2009, according to China’s Environmental Protection Ministry.


Absent the development of these risks, we expect the price of copper to decline from here as the fundamental and currency tailwinds look to unwind. For now, copper is bullish from a TRADE ($3.25/lb) and TREND ($3.14/lb) perspective with TRADE resistance at $3.31/lb. 


Darius Dale


Bear Market Macro: SP500 Levels, Refreshed...

One of the hallmarks of bear markets is that they rise to lower-highs on low-volume bids. We affectionately refer to this as hope.


Hope, unfortunately, is not an investment process…


After a low-volume rally on this morning’s open, the SP500 could not hold above our most immediate term TRADE line of resistance (1082). All the while, the dominating intermediate term TREND line up at 1144 continues to cast its shadow of doubt.


While we won’t see any of the shadow inventory in tomorrow’s US Existing Home sales report for July, we’ll see plenty of reported inventory. Don’t forget that despite the tax credit in the June data, housing inventory was already moving up into the right hand corner of your charting system.


The overall market is a very dynamic ecosystem that absorbs both inside and reported information. That’s why we apply the principles of chaos theory to manage risk around it.  Our refreshed risk management level of immediate term TRADE support is 1059.


We continue to be short both the SP500 (SPY) and Russell 2000 (IWM) in the Hedgeye Virtual Portfolio. We think this week’s US housing data will be plenty Bearish Enough.


Keith R. McCullough
Chief Executive Officer


Bear Market Macro: SP500 Levels, Refreshed... - 5


From our understanding, Wynn is holding only around 2.6% thus far in August, which explains some of the sequential market share loss.



We continue to think the Macau narrative for Wynn may soon turn to Encore and the seemingly lack of incremental contribution from the sister property.  Market share will likely be a focus.


In July, the Wynn properties posted a disappointing market share of 15%, the lowest full month share since Encore opened in April.  Through the 8/15, Wynn's share fell further, to only 12.8%.  By contrast, Wynn's June market share was 17.4% and averaged 14.2% in the 12 months prior to Encore opening.


Our sources indicated that Wynn's August hold % fell to 2.6%, below a Wynn's average hold of of 3% since 2007.  We calculate that if Wynn's hold was 3%, its market share would have been 14% in the first half of August.  14% is not good enough either.


We recognize that we don't have the data yet to normalize everyone's share so this analysis is not as useful as it could be.  However, what is clear is that Wynn is on track to post its second straight month of disappointing market share with Encore.  Given the overall market strength, this may not matter but at some point, overall growth will slow and market share will become a more important metric in the eyes of investors.  At that point, a narrative of disappointing ROI from Encore may be the story that will start to be told.

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Burger King is scheduled to release earnings tomorrow pre-open, here is a look at guidance and key focus points.


I continue to hold my view that trends at MCD are impeding its fellow mature hamburger chains from posting better-than-expected results.  Commodity prices, (beef, pork, and wheat in particular) are trending higher and this will make it difficult to maintain margins in the second half of calendar 2010. 


Burger King introduced a new premium product, Fire-Grilled Ribs, to major markets in May.  Despite my initial skepticism, reports indicate that sales of the product have been going well.  Also, the higher price point must be assuaging the painful squeeze franchisees endured during the $1 Double Cheeseburger promotion. 



  • Per StreetAccount, the Street is anticipating a US & Canada system comparable store sales number of -1.7% which would imply a sequential slowing of two-year average trends of 85 bps
  • To maintain or sequentially improve two-year average US & Canada system comparable store sales trends, BKC will need to print a number of 0% or better


  • As it relates to fourth quarter fiscal 2010 worldwide system comparable sales, the company expects worldwide system comparable sales to improve sequentially compared to the reported third quarter fiscal 2010 worldwide system comparable sales of negative 3.7 percent.
  • April traffic in the U.S. continues to be positive while comp sales, albeit negative, have been slightly better than March.  “Cautiously optimistic” outlook for sales in the rest of the quarter.
  • Over the “long term”, average annual worldwide comparable sales growth of 2 to 3%.
  • Over the “long term”, average annual revenue growth of 6 to 7%.
  • No EPS guidance due to continued consumer uncertainties.
  • U.S. food costs are expected to increase 4% in the fourth quarter versus last year, primarily driven by an increase in beef prices offset by a decrease in contracted chicken costs and other commodity decreases.
  • The company is on track in both net new restaurant openings and on restaurant reimaging initiatives.  The guidance at the start of the fiscal year was for net restaurant growth, over the “long term”, of 3 to 4%.
  • In June, management took down the net restaurant growth number for FY10 from 150 to 300 to 230 to 250 due to exiting the Israeli market


  • Food costs increased during the 3QFY10 quarter due primarily to a 9% jump in beef costs


Howard Penney

Managing Director

Getting Ready To Short Natty

Conclusion: While it is not quite at our price, natural gas is broken from a quantitative perspective and negative fundamentals continue to build and loom.


While I was out on vacation last week, the research machine at Hedgeye continued to grind forward.  Our Energy Sector Head (who is launching next month) Lou Gagliardi, continued to hit the team with updates from the global oil patch.  Lou forgets more about the energy industry in a day than most of us will ever know, so his thoughts are always insightful and worth reading. I’ve borrowed from his notes to outline our key negative fundamental case for natural gas in the report below.  In summary, the bearish case is threefold: growing inventory, accelerating production, and likelihood of a future step down in future demand.


Production – Over the past five years in the United States the advancement of drilling technology has allowed domestic gas producers to dramatically ramp up production due to the ability to access more diverse natural gas basins, in particular shale areas.  As a result of this advancement in technology, we have seen a step up in the amount of natural gas produced in the domestic United States.  Both 2008 and 2009 showed domestic production levels of north of 20 million Mcf for the full year.  The last time we saw this type of production was in 1974!  As a result of technology and massive shale development, we are in a new paradigm of natural gas production in the U.S., which will serve to keep a lid on the upside to the price of the commodity.  We have highlighted this point in the chart immediately below, which shows monthly production going back to 1997.


Getting Ready To Short Natty - 2


Looking forward production growth is also poised to accelerate in the U.S. based on rig count.  Since March 5, 2010, rig count has been growing on a year-over-year basis.  In fact, since the second week of July, rig count in the U.S. has been up more than 40% versus last year every week and currently there are 985 natural gas rigs operating in the U.S.  The more drilling that occurs, the more that future production will grow.


Inventory – Natural gas stocks closed this week at 3,012 Bcf, which surpassed the 3,000 Bcf mark for the first time since January 1, 2010.  While we are heading into the period in which there are seasonal builds of natural gas, storage levels remain at the high end of their 5-year range. The five year maximum for the most recently reported week is 3,142 Bcf, the five year minimum is 2,816, and the average for that period is 2,816.  Currently, inventory in the U.S. is sitting at 7% above its 5-year average, and just 4% below the maximum.


The maximum levels of natural gas in storage occurred last year.  In fact, on August 31, 2009, natural gas hit a record for August of 3,352 Bcf in storage, but currently levels are slowly inching towards those levels.  Interestingly, despite the fact the inventory levels are nearing 2009 record levels and production is poised to accelerate given rig activity, the price of natural gas is well above levels of 2009.  In fact, the September 2010 contract is currently priced about 49% higher than the expiration price of $2.84/MMBtu for the September 2009 contract.


Demand – Given that natural gas is a domestic based commodity, it is primarily driven by economic growth within the United States (and also coal prices which lead to switching in power plants).  As we have aggressively been articulating, we believe the U.S. economy is poised to slow sequentially, which will be negative for energy consumption.  Slow growth in the U.S. has a negative impact on natural gas price.  In fact, as we wrote on August 11th, 2010:


“We also took a quick look at the returns of natural gas, the commodity which is priced domestically and most directly impacted by U.S. economic growth.  Not surprisingly, the results were very similar.  For this analysis we were only able to look at the past 10-years of data, but in the four years with the highest GDP growth in that period the average year-over-year price gain for natural gas was +16.8%, while in the four years with the lowest GDP growth prices declined an average of (-3.4%) year-over-year.”


The statistic above is likely not surprising given that more than 1/3rd of natural gas use in the United States is used for industrial purposes, which are highly dependent on economic growth.


In the chart below, we’ve highlighted a price chart of natural gas with its TREND line at $4.49 as of the open today.  While we aren’t short currently, given the negative fundamental backdrop and bearish quantitative set up, we will likely be looking to short at, or around, that level.


Daryl G. Jones

Managing Director


Getting Ready To Short Natty - 1


This note was originally published at 8am this morning. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK in real-time, published by 8am every trading day.




EARLY LOOK: The Deuce - Chart 1



"Nobody can really guarantee the future. The best we can do is size up the chances, calculate the risks involved, estimate our ability to deal with them and make our plans with confidence."
- Henry Ford II

Staying as far away as I can from America’s professional politicians on Washington’s Sunday talk shows, this morning I’m rolling with an outstanding risk management quote from the man they called “The Deuce”, Henry Ford’s grandson, Henry Ford II.
According to my good friend who is currently working for Ford, Henry Ford II “doesn’t quite get the historical credit he deserves and is often remembered for his personal gruffness and feud’s with Lee Iacocca in the 1970’s, but his leadership and accomplishments during his era at Ford were amazing.”
After serving in the Navy in WWII, Henry Ford II came home to rid his family’s company of complacency and bureaucracy. He may not have been as “experienced” or as “polished” as some of America’s corporate executives are today, but as President of the Ford Motor Company (1945-1960) then CEO (1960-1979), he definitely sized up chances, calculated risks, and executed his plans with confidence.
Ford came public under Henry Ford II’s leadership in 1956. Don’t worry, I’m not wasting this morning’s missive on General Disaster’s pending IPO.  Instead, I’m going to get right into the math associated with last week’s macro market moves and focus specifically on the impact of another deuce – the US Dollar not going down for the 2nd week in a row!
Now before we get into some Dollar correlations, let’s first realize this: a deuce does not a TREND make. In our TRADE, TREND, and TAIL risk management process we are wed to 3s. In order for us to start thinking about shifting a strategy point of view (like covering our short position in the USD), we need to see at least 3 consecutive weeks confirm the direction of price.
Last week the US Dollar Index was barely up week-over-week (by +0.13%) for just the 2nd week in the last 12, closing out the week at $83.06. This followed the prior week’s significant +3.2% week-over-week move off of its recent 12-week low after Ben Bernanke didn’t give into the Fiat Fools begging for quantitatively easing America into becoming the debt-laden bureaucracy of Japan.
Measuring the math associated with a US Dollar Index not going down on our most immediate term risk management duration (TRADE = 3-weeks or less) is actually quite revealing.
The following are the 3 most negative TRADE (or inverse) correlations to the US Dollar:

  • SP500 = -0.97
  • Crude Oil = -0.94
  • Commodity Index = -0.93

Here are the 3 most positive TRADE correlations to the US Dollar (again, using 3-weeks or less as our duration):

  • Coffee = +0.85
  • Cotton = +0.79
  • Gold = +0.75

In other words, the decision by the Fed NOT to obliterate the credibility of America’s currency in one fell swoop has really hammered US stocks and the price of oil. The size of the Fed’s balance sheet actually contracted for once last week by $13.9B to $2.32 TRILLION.
Maybe not so ironically, prices at the pump going down also lifted US Consumer Confidence. In the last 2 weeks, despite stocks going down, the ABC/Washington Post Consumer Confidence reading has improved from minus -50 to minus -45.
In the very immediate term, could it be that The Deuce  of Dollar UP has provided Americans with some things that they really want?

  1. The value of their currency stopped burning.
  2. The price of oil is down -8.6% in the last 2 weeks.
  3. The probability of their least favorite American politician being voted out keeps going up.


Food for thought on a Monday morning in America where all that is conventional wisdom about the Fiat Republic’s dollar devaluation policy is ripe for change. It’s time we “estimate our ability to deal” with change and start leading this country with confidence.
My immediate term TRADE support and resistance lines for the SP500 are now 1059 and 1087, respectively.
Best of luck out there today,

Early Look

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