Archive for the ‘Thematic Piece’ Category

A Review of my EQ Based Global Macro Trading Ideas

December 22nd, 2009 Michael McDonough Comments off

Today I wanted to quickly highlight the performance of my equity based trading strategies around my global macro economic investment thesis.

Emerging markets: I continue to believe that emerging-market growth and equity performance — especially in countries with a strong consumer base — will continue to outpace developed nations in 2010. Therefore, you should still consider long positions in iShares Brazil (EWZ) and iShares FTSE/Xinhua China 25 (FXI).

Risks in Brazil include an eventual uptick in the central bank’s Selic rate, which could stymie the country’s growth. In China, early inflationary warnings could eventually lead to tightening actions by the government that could hamper growth. Still, I believe upside potential outweighs the risks over the short term. For more details on this trade idea, please see my piece published on Oct. 9 titled “Easy Money is a Big Driver.”

Steel: The continuing global economic recovery combined with relatively conservative steel demand estimates for 2010 should help propel steel prices in the year ahead. In addition, the potential consolidation of inefficient Chinese steel mills may lead to reduced output, placing excess demand in a favorable pricing environment on South Korea’s Posco (PKX ) and Japan’s JFE Holdings. Strong demand in other emerging markets should help to support Gerdau (GGB). Risks to these investments include a weaker-than-anticipated global recovery or an oversupply of steel weighing on prices. See my column from Oct 16, “Coal Seeing Recovery in Foreign Demand,” for more thoughts on this theme.

Japan: Not much has changed on my bearish view toward the yen since I published a piece called simply, “How to Play Japan” back on Nov. 13. In fact, I would argue that support for any further yen appreciation has dissolved, creating a good entry point for a short position via puts on ProShares Ultra Yen (YCL) or a straight long position in ProShares UltraShort Yen (YCS). This trade depends heavily on timing, and I anticipate that the yen should move back above 100 per U.S. dollar over the coming months.Japan’s woes have recently been noticed by Moody’s, where a senior vice president was recently quoted by Bloomberg as saying, “Things we are most concerned about are the lack of well-articulated long-term fiscal consolidation and a debt reduction plan.”

Rail: Warren Buffett’s purchase of Burlington Northern Santa Fe (BNI) provided a strong boost for railroads and provided Buffett with a bet not only on long-term U.S. recovery, but also on coal. I recommended CSX (CSX), Union Pacific (UNP) and Norfolk Southern (NSC) based on what I assumed to be Buffett’s investment thesis. These positions may not have the same short-term upside potential as some of my other ideas, but they should provide some longer-term value in your portfolio. My piece from Nov. 13, “Coal in Your Stocking: Hypocrisy, Senility or Common Sense?” has more information about this trading idea.

Agriculture: Ag products will see more demand as developing nations begin to eat more like developed countries. Ag stocks also provide investors with a good real-time hedge against inflation and thus far have lagged pricing increments seen in other commodities. I maintain my constructive long-term view on wheat, corn, sugar, soybean, cocoa and hogs. One way you might play these positions is through exchange-traded fund PowerShares DB Agriculture (DBA), which is unique in that it invests in actual commodities futures vs. agricultural companies. For more information on trades in the ag sector, please see my piece published on Nov. 20 called, “Talking Turkey on Agriculture Trends.”

China energy: Very little has changed since I first published my thesis on Chinese energy companies last week, “Three Ways to Play China Oil & Gas for 2010.” I still believe that PetroChina (PTR), Sinopec (SNP), and CNOOC (CEO) are all well positioned to take advantage of China’s growing energy and natural gas market in the year ahead.

Global Macro Trading IdeasSource: Bloomberg


An Economic Wrestling Match For Our Future

December 14th, 2009 Michael McDonough Comments off

As the invisible hand of the market continues wrestling the imprudent hand of governments; consequences will be felt across the globe as one hand hits the table…

Government stimulus and monetary policy has undoubtedly led us out of one of the worst recessions since the Great Depression, but what impact will these policies have on the future?  Many economists agree that the current growth period has been significantly bolstered by fiscal stimulus, which has failed to substantially address a lack in final demand and create what many would consider to be a sustained recovery.  Let’s take a look at this chart published by Goldman Sach’s chief economist Jan Hatzius depicting his firm’s view on the medium term impact of the fiscal stimulus package on GDP:

GS Fiscal Stimulus on GDPSource: Goldman Sachs

Not pretty, especially considering there are no indications that final demand is prepared to take the lead as this recoveries growth engine.  Given the nature of politics and the election cycle it makes sense for some politicians to be more concerned over short-term outcomes versus long-term consequences, at least if they want to retain their jobs.  And who wants to be unemployed right now?

Funds for the government’s stimulus package do not just appear; they were borrowed.  Not only were they borrowed, but they were borrowed at teaser rates subprime Vegas home buyers would have been happy with several years ago.  It is my belief over the long-term the government’s soaring debt load combined with an eventual increment in rates will lead to substantially higher taxes in the US and lower growth prospects for the country.  What we have done is borrow from future growth for the gains we are realizing today.

Turning to the central bank, copious amounts of liquidity have been poured into the financial system to help stave off deflation and support asset prices.  These funds have not yet triggered significant inflationary concerns, because they have simply made up for a slowdown in the velocity of money.  What I mean is the fed’s injections counteracted an essential halt in lending markets; making up for borrowed money that would have existed to prop prices.  But, this also means that as banks turn back on the lending spicket excess liquidity in the system can quickly turn into fuel for inflation.  This will force the Fed to react by withdrawing liquidity from the system, and hiking the target rate.  The big question will if the fed can remove excess  liquidity faster than inflation can take root, and if so will unemployment still be at uncomfortably high levels?  Probably.

All of these questions will be answered in time, but I have no doubt we will be paying for today’s growth well into the future.  Will it be worth the price? We can only hope.


Dubai’s Downfall

November 27th, 2009 Michael McDonough Comments off

Here is an excerpt from my Real Money column being published this morning:

Burj DubaiIn 1909 the completion of the Metropolitan Life Building—the world’s tallest building—coincided with the beginning of a two year recession in the US.  Between 1929 and 1931 40 Wall Street, the Empire State Building, and the Chrysler Building were all erected in a bid to build the world’s tallest building; the Empire State Building eventually won this title, but again the construction of these grandiose buildings coincided with the onset of economic strife, in this case the Great Depression.  I think you see where I am going, but I should add the construction of the Sears Tower, the World Trade Center’s twin towers, and Malaysia’s Petronas Towers—all vying for the title of world’s tallest building—culminated in similar economic turmoil.

Coincidence or not the Burj Dubai, the tallest man-made structure ever constructed, is preparing for occupancy in Dubai.  With that said credit markets around the globe were shaken this week on news from Dubai.  Dubai World, a state-owned enterprise and primary investment vehicle, asked banks to allow the organization to suspend debt repayments for six months; the terms are still unclear, but could potentially be considered a default.  According to Standard and Poor’s, “In our view, such a restructuring may be considered a default under our default criteria, and represents the failure of the Dubai government (not rated) to provide timely financial support to a core government-related entity.”

Maybe I am too optimistic, but I believe this situation should lead to some good buying opportunities over the short-term, depending on where markets trade today.  Already investors immediate rush to safety, out of what are perceived to be high risk currencies into safe haven currencies, have created an excellent entry point into a trade I pointed out a couple of weeks ago—shorting the Yen.  The JPY appreciated to a 14 year high against the USD yesterday, increasing speculation that the Japanese government may be forced to intervene in the market, potentially creating a floor for the currency.  I still hold a bearish medium term view on the Yen—please see my piece on how to play Japan—and will likely increase my position in The Yen Ultrashort (YCS) or purchase puts in Long Yen ETF (YCL) depending on how the market opens this morning.


Talking Turkey on Agriculture Trends

November 20th, 2009 Michael McDonough Comments off

An excerpt from today’s column on RealMoney…

“In tune with the Thanksgiving spirit–eating–I want to discuss a budding topic that’s garnering more attention lately from a growing number of my clients: food, or more specifically, agriculture. There are many ways to tackle this topic, but what I wanted to highlight today is the growing caloric intake of the developing world, especially China.

Developing-world diets have started a path of convergence with their developed-world counterparts, meaning that as disposable incomes within these countries have risen, consumers have begun to demand more complex proteins: meat. To help put this into perspective, if the present trend were to continue and if Chinese and Indian meat consumption were to converge with that of the U.S., global caloric intake could double by 2050.”

I go on to recommend the ETF DBA as a good play on this theme as well as a good hedge against inflation.  Please see the entire column here.


Coal in Your Stocking: Hypocrisy, Senility or Common Sense?

November 13th, 2009 Michael McDonough Comments off

An excerpt from “Coal in Your Stocking: Hypocrisy, Senility or Common Sense?”

Joe, a retired coal miner in WV

Joe, a retired coal miner in WV

At lunch last week with former colleague and Wall Street writer/editor Bill Johnsen, the topic du jour was Warren Buffett’s Berkshire Hathaway (BRK.A) purchase of Burlington Northern Santa Fe (BNI). Bill wanted to know if I thought the acquisition was an act of hypocrisy, senility, or common sense.

I said it was the latter, Bill agreed, and we held forth on how history should eventually prove Mr. Buffett has made another wise investment. Not only is Buffett betting on the resilience of the U.S. economy, but on an energy source arguably taking as much heat as it provides in Washington, coal.

For the remainder of the piece please visit’s Real Money site by clicking here:


Be On The Lookout….

November 12th, 2009 Michael McDonough Comments off

Tomorrow I will be publishing an interesting piece on’s Real Money section titled “Coal in your stocking: hypocrisy, senility, or common sense?“  The piece discusses Mr. Buffett’s recent acquisition of BNSF, and highlights his indirect bet on coal.  The piece also highlights some trading ideas in the coal and railroad sectors that you may find interesting if you agree with Mr. Buffett’s implied investment thesis.


Chinese Consumers May Have Only Begun to Teethe

November 9th, 2009 Michael McDonough Comments off

Since China opened the flood gates to foreign investment in the 1990s, the country has significantly outpaced the developed world, especially the US, in terms of economic growth (see Chinese vs. US real GDP growth chart).

Chinese GDP

Consequences of China’s success have included increased urbanization (see population chart) and a burgeoning middle class.  Never before in China’s modern history have so many had so much, and with a population of over 1.3bn this has created more than just a blip on the map.

China Pop

One statistic that best represents China’s blossoming middle class is domestic car sales, which have risen quite dramatically over the past five years (see domestic Chinese auto sales chart). But these increments are likely just the tip of the iceberg.

China Autos

Prior to the global financial crisis, Chinese consumption was experiencing solid growth on the back of rising incoming bolstered by large levels of investment and a strong export industry (see consumption and income chart).

China Consumption

However, as economic turmoil spread around the globe, it became clear decoupling was more myth than reality, forcing the Chinese government to react.  Realizing the frailties of an export-oriented growth model in the face of an external crisis, the Chinese government introduced an unprecedented US$586bn stimulus package designed to stoke domestic demand.  The result: Chinese consumption remained robust while domestic demand in the US faced significant declines (see chart US retail sales vs. China).

China US Retail Sales

Over the course of 2009, US corporations with high exposure to the region sought relief in China to help offset significant losses back home.  One measure of China’s resilience over the US market is the fact that on a year over year basis, Chinese imports from the US fell by only -US$842mn, while Chinese exports to the US plummeted -US$5.9bn (albeit from a higher base) (see yearly change chart).  Additionally, not all goods sold by US corporations in China are imported; many US companies have partnerships with Chinese companies and produce goods domestically.  The list of companies that admitted to benefiting from strong consumer demand in China include Intel Corp., Caterpillar Inc., Coca-Cola, Alcoa Inc., Altera Corp., and Cummins Inc., just to name a few.  Recently, Ford Motor Company announced the construction of a third factory in China to produce high-end sedans for sale in the country.  There is no doubt the short-term effects of strong Chinese domestic demand has been positive for western companies. The question is, is it sustainable into the future?

China Trade

The answer to that appears to be yes.  Increments in consumption over the past decade may only be a drop in the bucket compared to the country’s full long-term potential. China’s government has realized the shortcomings of its investment and export led growth strategies, and will continue to focus on policy toward domestic demand.   As Chinese Premier Wen Jiabao put it, “to boost domestic demand is a long-term strategic policy for China’s economic growth and the way for us to tackle the financial crisis and stave off external risks.”

But how much slack is in the system? China may have the world’s third largest economy, but on a per capita basis, China doesn’t even rank among the top 100 nations, falling between Armenia and Iraq (see per capita GDP chart). However, its performance in this metric has rapidly been improving.

China US per capita gdp

According to McKinsey Global Institute (MGI), present day China, at least in terms of per capita GDP, holds a striking resemblance to the US circa 1850, the same period in which the US was undergoing its own industrial revolution.  However, unlike the US in 1850, China’s consumption as a portion of GDP is amongst the lowest in the world — herein may lie the key to China’s true potential (see chart China’s personal consumption to GDP vs. US & Japan).

China US Cons/GDP

According to MGI, by 2025, with the adoption of effective government policies, the proportion of GDP attributable to consumption could recover recent losses begin catching up with the rest of the world.  MGI estimates that under a best case scenario, China would be able to enlarge consumption’s share of GDP from the present level of 36% to 50% by 2025, while elevating nominal GDP to US$13.2trn, versus US$4.4trn in 2008.  These estimates are arguably overly optimistic, but nevertheless the implications of such a jump are enormous—even MGI’s baseline forecast with policy changes has consumption/GDP moving up to 45.2%.  If these forecasts come to fruition, China’s share of global consumption would jump to between 11% and 13%, meaning a quarter of all new global demand would be derived from the country.  Applying linear growth rates to the organization’s forecasts, we can interpolate the projected growth of Chinese consumption through 2025 (see chart consumption forecast).  Putting this into dollar terms, Chinese household consumption could increase from US$1.4trn in 2007 to US$6.6trn – US$5.2trn – in just 18 years. Contrast this to the past 20 years, during which Chinese household consumption increased by only US$1.3trn.  Considering the effect US$0.7trn in consumption growth has brought China since 2000, any realization toward China’s full potential could surely change the world as we know it.

China forecast

Source for all Charts: MGI & Bloomberg


Positioning Yourself for Japan’s Potential Demise…

October 28th, 2009 Michael McDonough 5 comments

-Strong domestic demand for Japanese government bonds has permitted Japan to keep interest rates at or near 0 despite significant increases to the government’s debt burden, with no significant currency depreciation, and almost no economic growth. But, this model may be coming to an end

-An aging Japanese population will have several negative effects on the economy: 1) Higher taxes to fund the country’s pay as you go social security system. 2) Retirees will begin drawing from savings to fund retirements. & 3) Reduced demand for JGB’s will force the government to seek capital outside of Japan, which should lead to a run-up in rates. Any increase in interest rates should have substantial effects on the government’s ability to finance it’s debt.

-The ‘illusion’ of the YEN being a ‘safe-haven’ currency could soon dissipate. Not to mention the aforementioned issues, the bulk of Japan’s economic growth–and decline–has stemmed from the export sector. A strengthening Yen against its trading partners will add further pressure to this sector, and place additional pressure on Japan’s growth going forward.

Take a short position on the Yen versus USD:

*Buy USD/JPY puts

*Short YEN against USD (ETF: YCS)

Open a position to take advantage of anticipated rise in Japanese rates:

*Buy call options on Japanese yields

**For a more detailed look into this topic please see my column posted on’s RealMoney section.


Sprott Asset Management Raises Concerns Over US Government’s Financial Viability

October 27th, 2009 Michael McDonough Comments off

In a monthly investment strategy letter written by Eric Sprott and David Franklin of Sprott Asset Management titled ‘Surreality Check… Dead Government Walking’ they convey their concerns over the US government’s ability to finance its growing burden.  In the letter they clearly state:

The United States Government is on a trajectory to default on their obligations. In its current financial condition, it will not be able to fund its forecasted budget deficits and unfunded Social Security and Medicare promises on top of its current debt obligations.

In a similar letter in 2007 Sprott warned of the eventual bankruptcy of GM along with the risks associated with Fannie, Freddie, and Citi.  Now, however, the company claims the risks have shift from the private sector to the government as it continues to assume more and more  financial liabilities.  As Sprott put  it:

It’s time for another surreality check, but this time it isn’t the publicly traded companies that deserve attention, it’s the governments that have saved them. Make no mistake-–the dead men are still walking-–they’re just a lot bigger now than they were two years ago, and they don’t generate earnings-– they print money and tax their citizens.

See the full letter here


A Brief Global Macro View on the World’s Markets

October 12th, 2009 Michael McDonough Comments off

This is a very short global macro overview of today’s markets. I do not recommend any of the trades mentioned in this report, but hope they help reinforce your own view or help you generate some news ideas.

Monetary policy around the globe remains easy, providing ample liquidity and room for credit growth. Additionally, fiscal policy remains expansionary, and in some regions the full benefits have likely not yet been realized.

In the U.S., I believe we’ll discover that growth returned in the third quarter this year, primarily due to a turning in the inventory cycle (I will go into more detail on this topic in my Economic First Look when GDP is released). While the U.S. is only just returning to positive growth, some developing nations never experienced contraction or have already returned to growth mode. The trend of developing nations outpacing the developed world should continue and provide some potentially profitable investment opportunities, especially in Brazil and China.

But the punch bowl won’t last forever. An eventual resurgence of inflation and massive government deficits will eventually lead to higher rates and limited room for new fiscal stimulus. In fact, on Tuesday the Australian central bank surprised the world by announcing a rate hike to 3.25% from 3.00% on the back of perceived economic strength. Nevertheless, it will take some time — six to nine months — for other governments and central banks to catch up to Australia’s policy stance, leaving markets around the globe ripe for further appreciation.

As market conditions remain favorable for asset appreciation over the next six to nine months, developing nations — especially Brazil and China — will continue to outpace developed nations — especially the U.S. — in terms of economic growth and equity market performance. Therefore, you should consider long positions in ETFs based on the countries; those include iShares Brazil (EWZ) and iShares FTSE/Xinhua China 25 (FXI) .

Both of these countries have strong consumer stories:

* In Brazil, personal consumption has been leading its recovery. The country experienced 2.1% sequential growth in consumption in the second quarter, and the metric is generally anticipated to remain robust into 2010 on the back of easy monetary policy. The Brazilian unemployment rate has already fallen to 8.1% in August from 8.8% in May, and it’s widely anticipated to move between 7% and 8% over the coming months.

* In China, if you are a believer of the burgeoning middle-class story, you may want to look at companies like Zhongpin (HOGS) . Zhongpin is a Chinese meat and food products company, specializing in pork products. Additionally, expected increases in the caloric intake of the Chinese population could provide some opportunities in the global fertilizer and agricultural sector. I view China as a more volatile Brazil, with higher return potentials but also much more downside risk.

Additionally, I am bullish on the currencies of commodity-producing economics, including the Australian dollar, Brazilian real, Mexican peso, Chinese renminbi and Korean won. At the same time, I believe the Japanese yen, which has experienced significant appreciation over the past several months, may be overvalued due to deteriorating fundamentals. One way to play this view is taking a long position in Proshares UltraShort Yen (YCS) ETF.

Domestically, I am somewhat overweight on the U.S. technology sector via ETFs or Apple (AAPL) as a single name. It will also be interesting to monitor whether Verizon (VZ) is able to end AT&T’s (T) monopoly on the iPhone. Apple’s contract with AT&T is set to expire in June, and analysts are mixed over whether Verizon can expect to add the product to its line.

I am still somewhat bearish on the U.S. housing sector as foreclosures and mortgage delinquencies across all types of loans continue to weaken the sector. Moreover, the first-time homebuyer tax credit program is set to expire at the end of November; that incentive doubtless had an impact on recent home sales. Continued weakness in the housing sector may place some downward pressure on U.S. REITs.

The show won’t go on forever. A return to growth coupled with fears of economic overheating will cause central banks around the world — likely starting with emerging markets that have already returned to growth — to tighten monetary policy. While at the same time, developed nations will face the repercussions of swelling budget deficits. In Brazil, like in the U.S., monetary policy is expected to remain unchanged for most of 2010, which should provide further support for domestic assets.

In the near term, the biggest downside risk to this investment the possibility that central banks may tighten monetary policy prior to current expectations. But tightening is inevitable; rates in the U.S. will not remain at 0% forever. Once it becomes clear that central banks are approaching a tightening cycle, investors should consider taking profits on their equity positions. Ultimately, higher budget deficits in the U.S. combined with potentially momentous health care reform could lead to higher taxes and rates, coinciding with a period of subdued growth and elevated unemployment.

For more please see my column on