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Dr. Copper… Leading the Way Again?

Conclusion: We believe the recent strength in copper may be a leading indicator for China easing its tightening policies. This is bullish for Chinese Equities and may serve to keep a floor under copper prices going forward.


Position: Long Chinese equities (CAF); Short Copper (JJC)


As the facts change, we do. While we’d like to help our subscribers make money on 100% of our positions, the reality is we’re wrong on about 15% of them (14.4% on longs and 16.1% on shorts to be exact). Most importantly, however, rather than stay dogmatic about our losers, we accept the fact that markets don’t always trade in the direction our research suggests. 


In the spirit of this process, we went back to the drawing board on our short on Dr. Copper. After having put out a note early last week affirming our conviction in this position in light of the disastrous setup for growth and housing in the U.S., we revaluated the risks and have come to conclude that they are starting to outweigh the reward. Those risks include: Chinese demand accelerating, accelerating dollar debasement, and supply constraints.


We know growth is slowing globally. U.S. 2Q10 GDP came in at 1.6% (10bps below our estimate) and looks to continue rolling over sequentially driven largely by a weakening consumer (we are revising down our 3Q and 4Q GDP estimates to be released soon). As it relates to China, roughly one-fifth of all Chinese exports are to the U.S. so there will be negative knock-on effects in the Chinese economy as a result of slowing growth domestically. Understandably so, the likelihood that China reverses its tightening policies or accelerates the creation of policies designed to support domestic consumption increases with every incremental negative economic data point out of the U.S. and W. Europe – of which there will be plenty of going forward.  For instance, this morning the China Times reported that China’s State Administration of Taxation is considering “large” tax cuts to small and medium-sized businesses to support their growth and development. If enacted, this is incrementally bullish for Chinese employment and consumption.


Dr. Copper… Leading the Way Again? - 1


As it relates to the potential for dollar debasement, the Fed will have plenty of opportunities to quantitatively ease going forward given the negative economic backdrop domestically. If Bernanke and Co. give in to market pressure (which it appears he will based on his commentary out of Jackson Hole), 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).


Dr. Copper… Leading the Way Again? - 2


With regard to supply, copper inventories stocks on the London Metals Exchange continue to trend down and are at a nine-month low. We initially thought that those inventories would start to grow as growth slows globally, but the potential for accelerating demand out of China could serve to keep inventories in check at low levels.  While the global growth story may be in question, the domestic consumption growth story in China continues to accelerate.


Dr. Copper… Leading the Way Again? - 3 


In addition, some experts are predicting that there may be a deficit in copper next year as demand outstrips supply for the first time in four years.  The impact of a volatile few years of pricing is that there has been limited investment in mines and therefore there will be limited new supply coming on in the next few years.  According to Pan Pacific Copper, “With few new large-scale mines on the horizon and stagnation at existing facilities, in our view, price direction will be upwards given the approach of multiyear deficits.” So as demand naturally continues to grind higher, supply may actually take a few years to catch up.


In the end, Dr. Copper has a Ph.D. in being a leading indicator, particularly as it relates to China and global growth. We think the potential for policy easing and accelerated demand out of China is growing and that is a major factor we will continue to monitor as it relates to our long position in Chinese equities and short exposure to copper. As we’ve seen throughout the year, any easing of policy or rumors of easing is bullish for Chinese equities and will likely serve to keep a floor under copper in spite of the negative backdrop for real estate in the U.S.


Darius Dale



We have not published our official estimate for 3Q10 GDP growth yet, but suffice to say it will be substantially below the current 1.7% number and substantially below the 2.5% consensus for 3Q10.   


Today’s made-up numbers from the commerce department suggest that the economy is in fairly bad shape. 


The headlines read that “consumer spending in the U.S. rose more than forecast in July.”  Personal spending rose 0.4% (the most since March, up from 0% last month) and Personal Incomes rose 0.2% (slightly less that the Bloomberg consensus).  Despite the low level of in consumer confidence in the United States, the government is telling us that consumers are so confident they feel compelled to spend their savings (the savings rate dropped to 5.9% from 6.2% last month).  Importantly, disposable incomes (the real measure of the sustainability to consumer spending trends) dropped for the first time since January. 


Despite government CPI figures, key costs on the consumer’s income statement are inflating.  Food and energy costs, especially, are currently at elevated levels.  This is putting pressure on disposable income!


Without the consumer carrying the torch of GDP growth, there might not be any growth in 2H10.  To revisit last week’s GDP figures, the revision to 2Q GDP (dropping from 2.4% to 1.6%), 80% of the downside revision came from June’s reported trade deficit deterioration.  The rest was a negative revision in reported inventory build-up.  The only upside revision was reported in personal consumption. 


Despite the consumer spending more, the reaction of today's market is rational.  The reason for this is simple: increasing consumer spending is not sustainable given the current dynamics on the macro front.  Specifically, disposable income is contracting and this will place pressure on consumer spending.  Tracking the trend in consumer confidence presently indicates that this pressure should manifest itself sooner rather than later.


In turn, this will cause increased volatility in the trade data when it is released and any changes inventory trends.  To that end, today’s news from the Federal Reserve Bank of Dallas suggests that Texas manufacturing activity remains sluggish at best.  According to the Dallas FED “the new orders and growth rate of orders indexes pushed deeper into negative territory, indicating a further contraction of demand.”  Sluggish demand suggests no need to build inventories!      


Sequentially, the inventory contribution to the 2Q10 GDP figure dropped 2% quarter-to-quarter.  For the next two quarters, we are lapping against a 1.1% and 2.8% build in inventories in 3Q09 and 4Q09, respectively.  The current trends suggest that inventory adjustment could be a drag on GDP in 2H10.  The drag is not likely to be as substantial as what we saw during the economic collapse, when inventory adjustments lowered the published GDP growth rate by as much as 2.3% during the fourth quarter of 2008. It is clear from the 2% drop between 1Q10 and 2Q10 that the current cycle of inventory building has collapsed.


Given the current trade data, inventory trends and skittish consumer behavior, how is it possible that the USA will see 2.5% GDP growth in 3Q or 2.6% growth in 4Q10? 


While government spending has played a significant role in propping up the market, one externality of such grand-scale intervention is an added degree of uncertainty in the market place.  A lack of visibility is impeding companies from making decisions such as hiring new employees; Steve Wynn is one CEO that has been particularly vocal about the unpredictability of present-day Washington.   


The leveraging of America’s balance sheet has not created new wealth; rather, in creating a zero-yield environment, it has repelled capital and resources from her economy. 


Howard Penney

Managing Director


3Q GDP GROWTH - GDP inventory chart

COMPLIANCE: Dodd, Where's My Car?

COMPLIANCE: Dodd, Where's My Car? - Car covered in Snow

Never forget that Wall Street makes its money by getting its hands on yours.  Whether they pride themselves on their banking, their trading, or their research, marketing is the Sweet Spot in nearly every successful investment bank.  If they make enough people believe something is worth having, its price will rise.  If you didn’t make money on it, you have only yourself to blame.
When Goldman Sachs or George Soros says Buy Gold, it’s a lot different than when your Uncle Sidney winks at you over the remains of the Thanksgiving turkey and whispers “Precious metals!  Shhh!!!”  It is a given on Wall Street that by the time a major brokerage firm announces on the front page of the Journal that they are bullish on a sector, their own trading desk has already unloaded most of the house position to their “first call clients,” who they now have to get out of the position gracefully.  Which is where you come in.
Even the “smart money” tells the press what they’re buying, because the biggest hedge fund managers have the same problem we have with our measly little IRAs: if no one will trade with us, we can’t get out of our positions.
If a short-selling fund manager mentions in an interview that “XYZ Corp’s financials aren’t credible,” it could trigger a Congressional investigation.  This raises the issue of why regulators and legislators never complaint when money managers appear in the media and describe in loving detail what they are buying.  We leave it to greater analytical minds than ours – or more cynically twisted ones – to work out the correlation between, for example, the coincidental media reports in late July that both Soros and Paulson were buying gold, and the almost immediate spike in the price of GLD, the gold ETF.  Market participants are well aware that a major brokerage recommendation can move a stock.  Which begs the question: did Soros and Paulson call the bottom, or did they create it?
When hedge fund Jedi Master Stan Druckenmiller pulled the plug on Duquesne Asset Management last week, he said it’s a burden to have too much money under management.  This is why many hedge funds run what are called “silos,” large amounts of investor money centrally controlled, and parceled out by the management company’s senior partners to an array of management groups, each of whom runs an independent trading book.  In a siloed operation there is also a central trading function, a “house book,” run by traders who trade against positions taken by the individual portfolio managers, balancing positions to protect the investors’ money.
We think it odd that the same entity gets to be on both sides of a trade.  In the brokerage business, this is known as stock manipulation.  In the hedge fund world, it’s called “risk management.”
The siloed groups are required to be segregated from one another, and any hedge fund compliance officer will gladly show you the firm’s Chinese Wall policies.  But on the trading floor, managers sometimes talk to one another, which occasionally leads to odd coincidences, such as two managers starting to build a position in the same company.  Or one manager is able to get out of a large illiquid position when another manager mysteriously decides he needs to own the same security.
In the Bizzarro world of Political Correctness, Wall Street has largely phased out the expression “Chinese Wall,” and now refers to “Information Barriers,” as though there were something nasty and racial-profiley about referring to this Wonder of the World by its own name.
It is a wall.  And the Chinese built it, and they have been around ever since.  Rumor has it their economy is breathing down America’s neck.  And one must agree that they were right to fear what would happen when foreigners entered their land.  Thus, we are not sure which word is considered insulting: “Wall,” or “Chinese.”
As they say in China, the art of managing money is the art of having money to manage.  Other people’s money, that is.  China has America’s money to manage, in the form of a whopping bundle of Treasury debt.  Thus its central bank risks being pegged as one of the world’s worst-performing hedge funds.  Silo this!
So who’s in the driver’s seat here?
Wall Street has our money to manage, and for all brouhaha surrounding Dodd-Frankenstein, Wall Street is still in charge.  New regulation will not change that.  The Financial Times ran a full-page piece (27 August, “No Longer A Doormat”) that paints the Schapiro era as a success in the making.  But one fundamental problem has not gone away.  The article quotes a leading plaintiffs’ attorney saying “government lawyers are reluctant to offend those who might turn out to be their next employer.”  The key to lasting change in the regulatory agencies will be finding a way to close the door leading from Washington at $85,000 a year, to Wall Street at $850,000.
Pardon our demur.  Chairman Schapiro doesn’t appear to be in the driver’s seat.  The guys with the money are still very much at the wheel.  In a noble bit of teamwork, Treasury Secretary Geithner browbeat a group of Wall Street execs in a recent appearance at the NYU Stern School of Business.  He said, “your core challenge is to restore the trust and confidence of the American people and your customers and investors around the world.”  Pardon us while we guffaw, Mr. Secretary.  The only challenge facing Wall Street is finding the loopholes in Dodd-Frankenstein and coming up with unregulated businesses that the new legislation can not be stretched to cover.  Given that money buys talent, and Wall Street has all the money, we are once again betting on black.




Moshe Silver

Chief Compliance Officer

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EARLY LOOK: No more Bullets

This note was originally published at 8am this morning, August 30, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK in real-time, published by 8am every trading day.




“Show me a guy who can’t pitch inside and I’ll show you a loser.”
-Sandy Koufax



EARLY LOOK: No more Bullets - Sandy Koufax


Keith is vacationing this week in his hometown of Thunder Bay, Ontario.  As a result, various members of the Macro team will be batting leadoff and writing the Early Look throughout the week.  So, rather than just the McCullough fastball coming at you every morning, this week you will get an opportunity to see some other pitches from the Hedgeye Research Bullpen.
Sandy Koufax at his prime was one of the best pitchers the game of baseball has, and perhaps ever will, see on the mound.  He played his entire career with the Brooklyn / Los Angeles Dodgers.  The peak of his career was from 1961 to 1966.  In that period, Koufax won three unanimous Cy Young Awards (the first three time winner in baseball), he pitched four no hitters (the first pitcher in baseball to do so), and on September 9, 1965 he became the sixth pitcher in the modern era to throw a perfect game.
Then in 1966, at 30-years old, after pitching in the Major Leagues for only nine years, Sandy Koufax retired. Many baseball pundits called it premature, but Sandy knew the truth.  He was out of bullets.
As I contemplate the economic leadership of the country, primarily Chairman Bernanke and Secretary Treasury Timmy Geithner, I have no doubts that they are smart men and have had some good seasons in their careers. Their challenge now, of course, is to play the game in front of them.  While 0% interest rates for an extended period is an interesting experiment, akin to playing around with the knuckleball in practice, it is not indicative of a Perfect Policy Game.
Chairman Bernanke gave us a bit of an inside look at his next pitches on Friday when he stated the following in his speech:
“Notwithstanding the fact that the policy rate is near its zero lower bound, the Federal Reserve retains a number of tools and strategies for providing additional stimulus. I will focus here on three that have been part of recent staff analyses and discussion at FOMC meetings: (1) conducting additional purchases of longer-term securities, (2) modifying the Committee’s communication, and (3) reducing the interest paid on excess reserves. I will also comment on a fourth strategy, proposed by several economists–namely, that the FOMC increase its inflation goals.”
The Chairman indicated he would only use the additional policy bullets above if the U.S. economy slowed further and that he is expecting the U.S. economy to pick up in 2011.
The economic view from Hedgeye remains quite divergent from Chairman Bernanke’s.  We are pretty sure we couldn’t see a Koufax fastball, and we definitely don’t see an economic recovery in 2011.  The implications of Bernanke’s hope for a recovery in 2011 being wrong is the likelihood of more monetary pitches being thrown at the U.S. economy.
Unfortunately, we aren’t sure we have the right pitchers on the mound.  As Sandy Koufax said:
“A guy that throws what he intends to throw, that’s the sign of a good pitcher.”
One good metric for evaluating the economic leadership and their ability to know what they are pitching is the unemployment rate.  In the chart below, we’ve highlighted the unemployment of the G-7 over the past three years.  In order to further emphasize this point, we’ve highlighted directly below the increase (a positive number), or the decrease (a negative numbers), of unemployment for these nations over the past three years:
-          Canadian unemployment increased by 1.9%;
-          French unemployment increased by 1.7%;
-          German unemployment decreased by (1.3%);
-          Italian unemployment increased by 2.0%;
-          Japanese unemployment increased by 1.6%;
-          U.K unemployment increased by 2.5%; and
-          U.S. unemployment increased by 4.9%.



EARLY LOOK: No more Bullets - chart1



The scoreboard obviously doesn’t lie.  The score as it relates to the one critical factor of unemployment suggests that the economic leadership team of the United States needs to go down to the minors for some seasoning to work on their ability to hit the strike zone.  Most disconcerting, of course, is that one core objective of the stimulus plan was to offset an increase in unemployment.  When we see unemployment set to accelerate and government debt growing, it’s pretty clear our pitchers in Washington “didn’t throw what they intended.”
The one key takeaway from Chairman Bernanke’s speech should be that he remains somewhat naïve about how much the U.S. economy has slowed, and its ability to regain trend line growth.  But even if he does find economic faith and begin to understand the economic reality of the United States, the fact remains, the Chairman’s out of bullets.
Daryl G. Jones
Managing Director


When we get the August detail later this week, the numbers will show volume share erosion.  The pressure should continue.



We’ve written a lot recently about the diverging market share trends of some of the Macau participants, particularly Wynn and MPEL.  Hold percentages can fluctuate significantly month to month and we are pretty sure hold had a big impact in August.  However, at least for Wynn, there is a little more at play here and it is worth watching.


We should get the August monthly detail sometime later this week, which should show inadequate gaming volume growth from the opening of Encore.  Combined with the low hold percentage we wrote about last week, disappointing relative volumes will contribute to another month of sub 14% market share. 


The following chart shows Wynn’s monthly market share in Macau over the last two years.  Following the mid-April opening of Encore, market share peaked at 17.4% in June but dropped precipitously to 15.0% in July.  Most of that was hold but a potential sign of trouble emerged; some of the decline was also volume related as Rolling Chip share declined 60bps sequentially.




August will magnify that theme and that’s the part that should trouble investors.  We think Wynn’s RC volume share stays low and possibly falls from July.  So what’s going on?  In July, it looked like Galaxy and MPEL were a little more aggressive in compensating the junkets.  That may have continued this month but we think the bigger thief may actually be MGM.  Apparently, a big Wynn VIP operator, “David Star”, opened up at MGM and may be moving some business over there.  This would undoubtedly be the work of the new head of VIP ops, Mr. Kwong, who doesn’t officially start until September but is on site already.  As we’ve written about, Mr. Kwong is a top line guy focused on stealing VIP business.  With Wynn right next door with a huge junket business, the opportunity is there.


In addition to a heightened MGM VIP effort, Wynn is at risk from LVS.  LVS has said publicly that they will be ratcheting up efforts to grow VIP share.  To our knowledge, that effort has not yet begun.  With MGM already making headway and LVS soon to try, look for the narrative to turn to Encore and its seemingly lack of incremental contribution.


The Macau Metro Monitor, August 30th 2010



Sands' Acting CEO Leven still hopes to open sites 5 & 6 before 4Q 2011 as "there is much we can do to catch up."  Sands has warned that the delayed opening  will only be viable “once we have sufficient labor to ramp up our construction activity to requisite levels”.



Shuen Ka Hung, the director of the Labour Affairs Bureau said, "If the worker thinks the conditions that the employer is offering them are not sufficient or if they feel they are being mistreated, they can always go back to their homeland to find another job."  Mr. Shuen said that the Macau government believes it is possible for both the employers and the workers representatives to reach a “basic consensus” over the imposition of a minimum salary, which would include imported workers, in Macau by next year.


The Monetary Authority of Singapore, the Ministry of Finance and the Ministry of National Development said in a joint statement that the government will introduce three new measures to "temper sentiments" in the private property market and "encourage greater financial prudence among property purchasers." The new measures are: 1) raising the holding period of the seller's stamp duty from one to three years; 2) LTV limit for those with more than one outstanding housing loan will be lowered from 80% to 70%; 3) minimum cash payment increased from 5% to 10%.  Singapore’s property market would form a bubble if the current momentum continued, said Mah Bow Tan, Minister of National Development.  The measures will take immediate effect on August 30.


Meanwhile, Prime minister Lee said Singapore would limit its number of foreign workers to a third of the working population. About 80,000 foreign workers will be added in 2010, fewer than the 100,000 estimated earlier, he said.  Mr. Lee also said the two IRs have helped add 20,000 jobs and will contribute tax revenues to the government's coffers.

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 80.46%
  • SHORT SIGNALS 78.35%