Après La Pluie, Le Beau Temps

This past week we saw an interesting reversal in the Turkish lira. On Thursday morning, President Erdogan declared that Turkish interest rates needed to be lower to support the economy. The lira dropped over -3% against the dollar on the news. Then in the afternoon, in complete defiance of Erdogan, the Turkish central bank gave markets a surprise rate hike. The lira finished the day up +4%, with an 8% intraday swing. We noted this reversal in our Daily Update Friday morning and suggested that this key day reversal may be significant with the lira stopping short of its August low just above TRY 7.0/$. We reaffirm our recommendation for holding long Turkish lira assets. We believe that the “crisis” is overblown and is, in any case, fully price into the market after the -90% drop in the lira this year.

Other news this past week includes, well, old news. President Trump continues to tweet and the markets continue to respond. It is almost like a game of “Simon says”, where Trump is Simon and traders are the audience. The latest market-moving tweet from Trump came Thursday, in which he said that he is encouraged that a trade deal with China can be reached. The S&P 500 finished Thursday up +0.53%. Just wait, the next Trump threat over trade will cause an intraday move down. Stupid.

The key macroeconomic data from this past week was the inflation data. Producer prices actually ticked down in August, -0.1%, bring the year-to-year change to 2.8% (surprising economists which expected a 3.2% y/y rate). The consumer prices index rose +0.2% in August, pulling down the y/y number to 2.7% from 2.9% the prior month. Finally, import prices dropped -0.6% last month, again bringing down the year-to-year change to 3.7% from 4.9% and surprising the consensus. We do not expect inflation to begin to slow here. First, the fiscal and monetary stimulus is still present. Second, the bond market is telling us inflation is still ahead. Despite these soft inflation numbers, the U.S. 10-Year rate moved up 6 bp last week. The U.S. 5-Year rate moved up over 8 bp last week. And the U.S. 5-Year rate moved up over 7.5 bp last week! Inflation?

Take a look at the 10-2 yield curve, that we highlighted in our July 13, 2018 Commentary, “Two Charts To Watch”.

This does not look like the market expects deflation! When the Treasury Yield Curve inverts, markets will get much more agitated as everyone begins to wonder about the significance on the inversion. And higher rates will bring concerns about credit card debt, a latent crisis that the market has put on the backburner. We would avoid retail stocks as well as the homebuilders.

The Storm Is Running Its Course

We survived our third major hurricane in three years on Hilton Head. Florence hit further North, with the North Carolina taking the brunt of the storm. Readers know that the Natural Resource sector is also coming through a tempest. Almost a perfect storm, with everything going wrong for both miners and energy stocks. It does not seem logical. With all major central banks running QE programs (making national currencies a circumspect store of value) and inflation expectations rising, it seems paradoxical that gold and precious metals are falling. Similarly, with West Texas Crude Oil not far off cycle highs, it would seem irrational that the oilers are falling and underperforming the broad market.

We see several possible causes for divergence between oil prices and oil stocks. First, markets maybe expressing concern that the global economy is headed to severe recession and perhaps depression if Trump continues his trade war with most of the nations of the world. Next, there is always the risk that China could react to the tariff problem by selling its US Treasuries, which would boost rates in the US. As Fed hikes rates in the normal course over the next two years, pushing commercial bank rates higher, the heavy-debt companies are going to roll-over debt that carried very low rates from the past 10 years at, well, much higher rates. So, the debt loads of many Oil & Gas producers and land-bankers could strangle these companies. Finally, there is the possibility that Trump will flood America with crude oil from the Strategic Petroleum Reserve, which would crash crude prices and kill margins.

Markets are still pricing in these risks, even if we feel that these risks are now “over-priced” (vis-à-vis the probability of the above risk playing out). Our belief is that as these risks assuage and the market recognizes that oil prices above $65 will be sufficient to make the oilers’ margins acceptable, oil price stocks will catch up really quick. We know that this difficult period for resource stocks with pass and the sun will shine again on the sector. Perhaps we saw some light through the clouds last week at the oil E&P sector (XOP) rebounded + 4.3% off the lows early in the week. In any case, from a longer-term perspective, we can only be bullish on Natural Resources stocks at these levels.

In managing our Natural Resources portfolio, while we maintain a long-term focus, the volatility in this market requires us to be more active short-term to limit draw-downs. We have developed a methodology that both relies on our fundamental selection process (buying the stronger companies will ALWAYS payoff in the long-run) and monitors price on a daily basis to best align our holdings with relative price outperformers over shorter-term horizons.

Each weekend we update the fundamental data for all the companies in our database (over 4000). Companies meeting our strict selection criteria (either as Growth stocks or Value stocks) are placed in our Natural Resources Watch List / Trading Model.

While a bit busy at first glance, this model (updated with each day’s closing prices) gives us a vision on a stocks relative prices trends (vs the North America Natural Resources Index), the market price trend, alerts in the case of trend change, alerts in the case of break-outs (up or down), our RSI trading signal, and the current position of the stock over several time periods (telling us both the near-term potential and whether the stock is a momentum play or return-to-the-mean play). The model will give us the ability to (1) wait for a trend change higher before initiating a position in a candidate stock and (2) get daily alerts if one of our holdings begins to break-down.

As the Watch List is updated weekly, we have a dynamic short-list of candidates. Any company whose fundamental rank drops will be automatically removed from the Watch List as well as the portfolio.

Trade Recommendation

In the spirit on staying on the Natural Resources theme, our trade recommendation this week is for a long
position in a midstream oil & gas play. Antero Midstream Partners LP (NYSE ticker AM) participates in the
shale boom of energy recovery by gathering and compressing natural gas and providing water and waste
water services in the Appalachian Basin. The LP was formed as a drop-down entity by its sponsor
organization, Antero Resources, for whom it operated as a wholly owned subsidiary until the LP’s IPO in

Antero Midstream Partners LP has two operating segments: Gathering and Processing and Water Handling
and Treatment. Gathering and Processing generates roughly 50% of the company’s revenue by managing a
network of gathering pipelines, compressor stations, and processing and fractionation plants that collect and
process gas and oil from Antero Resources’ wells in West Virginia and Ohio. The Water Handling and
Treatment segment delivers fresh water to the wells from sources including the Ohio River, local reservoirs,
and several regional waterways. In sum, Antero Midstream Partners services the business of Antero
Resources (NYSE ticker AR), a mid-cap U.S. E&P oiler.

We like Antero Midstream Partners LP over its partner company Antero Resources for several reasons. First,
Antero Midstream is paying a healthy dividend that is growing regularly. Business is doing well. Investors
today earn a 5.41% annual dividend, paid quarterly, going forward.

As this is an LP, our WMA investment in Antero Midstream went into our Ultra Yield Strategy. Our Natural
Resources and Top Picks Strategies refrain from investing in LPs due to tax considerations for retirement
accounts from the partnership distributions.

Second, our fundamental rankings for Antero Midstream are very strong.

In addition to the dividend, we get excellent profitability and growth at a reasonable price.

Finally, we like Antero Midstream as they service the fracking industry. While Antero Resources account for
99% of sales, Antero Midstream now has the ability to solicit new refiners in their regions, with enormous
potential for growth as fracking will not slow down under Trump.

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