• Volume I, Issue 7

LGR Financial Newsletter

Volume I, Issue 7 (Released On March 23, 2014)

Hello all! So much has been happening recently that it’s hard to keep track. This Issue should have something for everyone, because the last two weeks provided so much material.

A quick headline – check out Life Time Fitness (Ticker: LTM). I pitched this company at the BC Investment Club this past week, and discovered in the process a great long-term company overpowering its competitors in the health club industry. If interested, just let me know and I’ll send you the key facts on the company.

On the docket for this Issue: a market update (focusing only on the biggest news stories), my portfolio update, and a report on commodities (requested by a reader). As always, I appreciate all feedback and recommendations for topics.


Market Summary:

(MARCH 10 – MARCH 21)

Last week, all major indexes had a bad week; with the S&P 500, the DJIA, and the NASDAQ down 1.96%, 2.35%, and 2.09% respectively. However, this week was much better with the S&P 500, the DJIA, and the NASDAQ re-gaining 1.37%, 1.44%, and 0.74% respectively. Also of interest, the S&P 500 reached a new all-time intra-day high on Friday, March 21st, although only barely. The S&P’s new high was at 1,883.97 vs. its previous all-time high of 1,883.57, so not too big a deal, but it made a few headlines. While the indexes were down overall over the past two weeks, there were some very good reasons why – and overall the two week period ended on a positive note.


Market Update:

(MARCH 10 – MARCH 21)

Major Market-moving Events for the Past Two Weeks:
Most headlines focused on the situation in Ukraine, which had a significant impact on financial markets. I will focus on the effect those stories had on capital markets, and especially on commodity markets (where they had a huge impact).

The Fed’s Open Market Committee (FOMC) made major statements, had a press conference, and gave economic projections on March 19th. The FOMC gave projections “for inflation and economic growth over the next 2 years and, more importantly, a breakdown of individual FOMC member’s interest rate forecasts” (Forexfactory.com, link #1). These statements were made particularly interesting by the fact that they marked Janet Yellen’s first press conference as the head of the Federal Reserve. Markets tend to trade in a volatile fashion and then head lower, as evidenced by the fact that “the S&P 500 has dropped during nine of the previous 13 days” (WSJ), when the Fed releases policy statements, and this week was no exception. The FOMC’s statements and economic projections were released at 2:00 PM and Janet Yellen began her press conference at 2:30 PM, and trading volume for the ETF, SPY, which tracks the performance of the S&P 500 index, was relatively light until it picked up around 12:30 PM and reached a crescendo after the statements were released. Although SPY declined 0.65% from 2:00 PM through the market’s close at 4:00 PM, up and down volume (a measure of the number of investors buying and selling) was relatively equal over that span of time, leading me to believe that the selling was mostly done by short-term speculators rather than large institutional investors. After doing a little due diligence I concluded that overall investors had a much less severe reaction to the statements released by the FOMC on that day than they had on past days, volume was lower on that day than on any of the past six days that the FOMC released statements (FOMC statements are scheduled for released 8 times a year). Overall, then, statements made by the FOMC went as expected.

The FOMC made downward revisions to their projections made in December, 2013, for Real GDP growth in 2014, and for the Official Unemployment Rate in 2014, and upward revisions for PCE inflation in 2014 (Federalreserve.gov, link #2). The only surprise in the FOMC statement was that, while “The Fed intends to keep short-term rates near zero into next year,” investors were able to sniff out “signs that rate increases might come a bit sooner and be a touch more aggressive than expected. Even though the Fed’s official policy statement sought to give assurances of continued low rates far into the future and Ms. Yellen played down rate-increase expectations, stock prices fell and longer-term rates on Treasury bonds moved up” (WSJ, link #3). The Fed also gave an update on their securities re-purchase program (known as Quantitative Easing), where they decided to continue their tapering of security purchases at a rate of a further $10 billion a month for April, and the continued tapering was expected by investors and likely received little attention (although the FOMC’s decision to continue tapering gave pleasant confirmation that the economy is continuing to improve).

Major Economic Data:
Retail sales improved for this month, as demonstrated by economic data released March 13th indicating that Core Retail Sales (m/m) improved at a higher rate of 0.3% vs. 0.2% expected, which is a nice improvement from last month’s number of 0% change during the “cold” winter months. However, Retail Sales only were able to meet expectations with a 0.3% change (m/m). The difference between Core Retail Sales and Retail Sales, as economists choose to represent the data, is that Retail Sales measures the “change in the total value of sales at the retail level” (Forexfactory.com), while Core Retail Sales excludes the prices of automobiles in its calculation and policies are made based off of Core Retail Sales. Although retail numbers improved, the preliminary survey from the University of Michigan (UoM) for Consumer Sentiment came in lower than expected at 79.9 vs. 81.9 expected and this is the lowest level the Preliminary UoM Consumer Sentiment report has shown for the past four months. Also, the jobs market looks to have improved over the past two weeks with the weekly number of Unemployment Claims for both weeks coming in lower than expected, 320K vs. 327K expected for this week and 315K vs. 334K expected for the week before.

Major News Stories:
Exits from the commodity exchange industry. J .P. Morgan Chase & Co. (NYSE: JPM) decided to “scale back its commodities business, striking a deal to sell its physical assets and trading arm to Swiss trader Mercuria Energy Group Ltd. for $3.5 billion in cash” (WSJ, link #4). JPM is one of many banks who have recently decided to sell their commodity trading branches, and “the sale comes amid a realignment in the global commodities-trading business as tighter regulation and capital constraints have made it more difficult for big Wall Street banks to participate in the high-cost, low-margin business” (WSJ, link #4). The “tighter regulation” refers to the Federal Reserve’s recent contemplation of whether “new rules are needed to limit banks’ exposure to the commodities trading amid concerns that these activities could pose a risk to financial stability and conflicts of interest” (WSJ, link #4). The article continues by listing names of other major banks that have recently made attempts (or are thinking about making attempts) to exit the commodity exchange industry, including: Morgan Stanley, Deutsche Bank, Goldman Sachs Group, Royal Bank of Scotland Group, and UBS. The move was clearly welcomed by investors and JPM’s stock price went up 5.93% this past week, which makes seeing as JPM’s revenue from commodities trading has declined for the past two years.


The U.S. Justice Department is forcing Toyota Motor Corp. to pay a record $1.2 billion criminal penalty “for misleading consumers about safety problems” (WSJ, link #5), which is “the largest to date against an auto maker and ends a four-year criminal probe into Toyota’s efforts to conceal and play down safety issues before government regulators and consumers. In 2010, a government regulator found that those safety issues had caused at least five deaths” (WSJ, link #5). The criminal penalty also acts as a strong warning to General Motors Co. because the “settlement comes as government is ramping up a similar investigation into GM’s handling of a faulty ignition switch that affected more than 1.6 million vehicles and has been linked to a dozen deaths. GM has acknowledged that it knew about the defect for years before it conducted a full recall” (WSJ, link #5).

T-Mobile’s strategy over the past year has been to take market share by offering to pay subscribers’ early termination fees (ETFs) if they are willing to switch to T-Mobile from other telecommunications companies. The move was an aggressively and costly one for T-Mobile, but it has been working and T-Mobile has seen significant growth in its subscriber base and increases in market share over the past year. T-Mobile is now taking its plans to increase market share one step further and, starting on March 24th, “T-Mobile will be the only place to pre-order the Samsung Galaxy S® 5 online and in-store for zero down (and 24 monthly payments) and with zero annual service contract, zero overages, zero hidden device costs, zero upgrade wait” (Yahoo Finance Businesswire.com, link #6). The company continued by pointing out that “because owners of Samsung Galaxy devices are among T-Mobile’s heaviest wireless data users, the longer term savings with T-Mobile can be huge. Families with four lines could see an average of over $1,200 in savings over a two-year period compared to families with AT&T and Verizon on a two year contract. And, as always, T-Mobile will pay the early termination fees for that entire family when they trade-in their devices to make the Simple Choice and come over to a better wireless experience” (Yahoo Finance – Businesswire.com, link #6).

General Electric Co. (NYSE: GE) announced on Thursday, March 13th, that “it will sell part of its credit-card unit in an initial public offering” (WSJ, link #7). As demonstrated by the following chart, GE’s “Synchrony Financial Unit” has seen a surge in profits since 2009, and GE believes that the credit-card unit can support itself on the public market. The Synchrony Financial Unit “is the largest U.S. issuer of credit cards in the names of retailers and other partners. The company’s biggest accounts include the retail giants J.C. Penney Co., Wal-Mart Stores Inc. and Lowe’s Inc” (WSJ, link #7).


The makers of the popular game “Candy Crush,” King Digital, will soon be doing an Initial Public Offering (IPO) and the company is “seeking a valuation of nearly $7.6 billion”, which would “make it the fifth-largest video game company traded in the U.S.” (news.investors.com, link #8). To that end, “The Dublin-based company said Wednesday that it plans to sell 22.2 million shares at $21 to $24 a share. King would raise about $532.8 million at the top end of the price range. It has an over-allotment option to sell 3.33 million additional shares, it revealed in a filing with the Securities and Exchange Commission. It plans to use the proceeds for working capital and acquisitions. King plans to list its shares on the New York Stock Exchange under the ticker symbol KING. The offering is scheduled to be priced on March 25 and the stock to start trading on March 26, Reuters reported” (news.investors.com, link #8). The New Yorker recently published an article about how King Digital is a “One-Hit Wonder,” which can be found by following the link:


Commodities Write Up:
The most recent changes in commodity prices can be summed up by the old adage “what goes up must eventually come down”. Most commodity prices were down over the past four weeks, but most of those declines came after very sharp increase in price so it is only natural to expect some dips in prices after sharp increases.
These moves in the commodities market, particularly due to events in Ukraine, make my delay in writing on this topic seem prescient. So, first, an update on commodity spot prices over the past four weeks:

  • For precious metals: The spot price of gold increased approximately 0.65%, the spot price of silver decreased approximately 7.1%, the spot price of platinum increased approximately 0.52%, and the spot price of palladium increased approximately 7.5%.
  • For Basic Metals: the spot price of copper decreased approximately 10.33%.
  • For Other Commodities: The spot price of heating oil decreased approximately 3.95%, the spot price of coffee increased approximately 0.59%***, the spot price of wheat increased approximately 14.28%, the spot price of gasoline unleaded decreased approximately 3.33%, the spot price of corn increased approximately 4.58%, the spot price of brent crude oil decreased approximately 2.33%, the spot price of light crude oil decreased approximately 2.70%, and the spot price of natural gas decreased approximately 30.77%.
  • The S&P GSCI Commodity Index: This index of commodity spot prices declined 1.50% over the past four weeks.

Moving forward, I focus on two things that have impacted commodity prices so far this year: the weather and the events in Ukraine.

The Weather's Effect On Commodity Prices:

Although the spot price of natural gas decreased approximately 30.77% in the past four weeks, the week before that natural gas rose to a new high (the highest spot price for natural gas in at least three years and possibly since 2008). A Bloomberg article released on February 18, 2013, around the time that natural gas prices were making their highs, stated that “a winter storm in the U.S. Northeast boosted fuel demand” (Bloomberg, link #9), so it is clear that many people use the cold weather to explain some rising commodity prices. The article goes on to mention that the cold weather we experienced this winter caused heating demand to drastically increase, and this “cut U.S. gas stockpiles to the least in 10 years, according to C.H. Guernsey & Co.” (Bloomberg, link #9).

While cold weather explained the increase in oil and natural gas prices, heat was responsible for the huge increases in coffee prices that we saw recently. A drought in Brazil, caused by “a heat wave and dry weather” that “drained reservoirs and scorched coffee plants” (Bloomberg, link #9), explains the sharp spike in the spot price of coffee. The spot price of coffee went up for seven straight weeks starting on January 27, 2013 (for a total increase in price of 58.40%) before declining 13.74% this past week. Has anyone noticed the price of their coffee at Starbucks going up? I haven’t… but maybe that’s just because BC doesn’t have a Starbucks on campus that I know of…The drought also affected the spot prices of soybeans and sugar, because Brazil is “the world’s biggest exporter of the crops” (Bloomberg, link #9), and the drought threatened the harvesting of crops. Sugar and soybeans saw increases in their spot prices of 21.05% and 10.27% respectively in the month of February.

The Events In Ukraine:

Ukraine has had a large impact on commodity prices, particularly natural gas.

I’ll get to that in a moment. But first, the one commodity I’m not so sure those events have impacted is gold. From the look of it, the financial media does not agree with me.

My Point Of View:

I understand people attribute last week’s decline in the spot price of gold to the “war premium” being taken away, but when I look at prices and compare them to the timeline for events in Ukraine I just don’t see the connection. In fact, when I look at gold’s spot price over the past few weeks the only thing I can think to myself is: Where was gold’s “war premium” to begin with? One thing is for certain, gold has been on a bull run since the beginning of 2014, with a 14.75% increase in gold’s spot price from its close on December 31, 2013 to its most-recent peak closing price on March 14th. From a brief search on the internet, I found out that the initial riots began in Ukraine on February 18th, and on that day the spot price for gold closed only $3.30 higher than it had the day before. Since February 18th, the spot price for gold has increased only about $12.30 an ounce or 0.93% to its most recent close on March 21st. USA TODAY reports that Crimea voted to join Russia last Sunday, March 16th, and that Ukrainians were preparing for war (USA TODAY, link #10). This past week, from March 17th to March 21st, the spot price of gold declined $48 an ounce (3.47%). In my opinion, speculation is the main driver in stock and commodity prices in the short-term so it is possible that some of these events have already been factored into the price but when I look at the price of gold recently I just don’t see much of a “premium” to begin with as a result of the events going on in Ukraine. If you don’t agree with me than we can talk about it further…

The Effect On The Price Of Natural Gas:

The Ukraine crisis has significantly impacted both the demand and supply for natural gas throughout Europe. The issue came to a head last Friday, when “Alexei Miller, chief executive of OAO Gazprom, said Ukraine owes the gas exporter $1.89 billion and had failed to meet a Friday deadline for payment of its February deliveries” (see Ukraine Article 1). Alexei Miller continued by saying that “failing to pay the bill could cause Gazprom to turn off the natural-gas spigot to Ukraine” (see Ukraine Article 1), which is almost impossible for Ukraine to do considering the fact that Ukraine is still in disarray after the recent change in government. “The threat raised the specter of a repeat of a shutdown in 2009 that cut off supplies to Ukraine for several weeks, raised prices and caused some shortages in other parts of Europe.” (see Ukraine Article 1)

The consequences to the market are as follows: If Russia cuts off the supply of natural gas to Ukraine, and if (as expected) the rest of the world responds by imposing trade sanctions on Russia, it will most likely cause an Aggregate Supply (AS) shock that should increase the price of natural gas globally (or at the very least in Europe) in the short term. Ukraine will be by far the worst affected, as “Ukraine relies on Russia for 70% of its natural-gas supply” (see Ukraine Article 1), but all Europe will feel the bite of rising natural gas prices. “Six European nations rely on Russia for 100% of their gas, while seven others get at least half their gas from Russia” (see Ukraine Article 1). European countries will soon be crying out for help.

In the past, that cry has been answered by other countries (specifically countries like the U.S. and countries in the Middle East), but it is unclear as of yet where help for this supply shock will come from. The sanctions on Russia have increased in severity recently, when the Organization for Economic Cooperation and Development (OECD) “postponed activities related to the accession process of the Russian Federation to the OECD for the time being” (See Ukraine Article 2), and it is reasonable to assume that the more strict, and more numerous, the sanctions are, the larger the impact the Aggregate Supply shock will have on the price of natural gas in the short run.
The open question: How much has the natural gas futures market already discounted this risk?

If you have any questions about this Issue of my Financial Newsletter please fill out the form below. I also appreciate receiving any comments you might have about what you just read, and I encourage you to send me ideas for topics that you would like to see me write about in the future. Thank you for reading!

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