“Dragonfly” hackers target U.S. energy company networks

“Dragonfly” hackers target U.S. energy company networks

From time to time, we are reminded of the growing threat of cyber attacks, one of the downsides of our increasingly Connected Society. This attack on computer networks of U.S. energy companies speaks to risks associated with the “industrialization of the internet” better known as the internet of things as part of our Safety & Security investing theme. These attacks and others like them suggest continued spending on cyber security from a widening group of companies that bode well for companies like Fortinet (FTNT), Palo Alto Networks (PAWN), Cisco Systems (CSCO) and other similar companies.

Symantec, a major cyber firm, says in a new report that hackers codenamed “Dragonfly” have been able to infiltrate energy sector computer networks with malicious emails, so-called “watering hole” attacks, and “Trojanized” software. The hackers – who according to Symantec have ties to the Russian government – may have compromised more than a dozen American companies in recent months.

“Dragonfly” has been linked to the Russian government by some cyber security experts but Symantec has not publicly blamed Russia.

The Department of Homeland Security (DHS) told CBS News that they are looking into the matter.

Source: Major cyber firm says hackers are targeting U.S. energy – CBS News

Enjoy today’s food price deflation, continued population growth means it’s not going to last forever

Enjoy today’s food price deflation, continued population growth means it’s not going to last forever

We have long held that a growing global population paired with an expanding middle-class, primarily in the emerging markets, would drive incremental demand for resources such as food, energy, and water.  A new report from published in the Proceedings of the National Academy of Sciences calls for the population in Sub-Saharan African countries to grow by another 1.3 billion over the next 30 plus years placing greater import demands for a variety of products, including cereals. Enjoy the current bout of food deflation, which is likely to get a tad better in the coming months thanks to a near record corn crop, but it’s not likely to last.

With a population expected to expand by another 1.3 billion people by 2050, Sub-saharan African countries will have to import half of all needed cereals in the next 30 years, if drastic changes to agricultural methods aren’t taken, the study concluded.

Over the past decade, development organizations have been working on improving the productivity of African farms to deal with food insecurity as the continent’s population booms. By closing the gap between what farms actually produce and what they could produce, Africa would have enough food to both feed itself and become a new breadbasket for the world.But according to a new study published in the Proceedings of the National Academy of Sciences, even closing that gap will not be enough to meet Africa’s food needs. The study, based on 10 countries that account for 58% of the continent’s arable land, found that closing that gap would only maintain the current level of self-sufficiency. It will also need to dramatically increase its agricultural efficiency. Right now, Africa imports 20% of its cereal needs, despite having a quarter of the world’s arable land.

Source: Study: Sub-Saharan Africa will soon have to import half of its needed cereals — Quartz

Apple’s Newest Business Isn’t at All What You Would Expect 

Apple’s Newest Business Isn’t at All What You Would Expect 

On Apple’s June quarter earnings call CEO Tim Cook shared expectations for the company’s Services revenue “to be the size of a Fortune 100 company next year.” We like the move into subscription services that generate recurring revenue and predictable cash flow, but we tend to doubt Apple Energy will share in those favorable characteristics. We’ll keep watching to see if this initiative becomes something of size to qualify Apple for our Scarce Resource investing theme.

Filings for Apple Energy list several assets, including a 130-megawatt solar farm near San Francisco, a 50-megawatt facility in Arizona, and another 19.9 megawatts in Nevada.

Rather than selling to the public, Apple is believed to be using Apple Energy simply to sell excess power to public utilities, helping to offset the cost of running its infrastructure. When and where possible, Apple uses solar as a primary source of “green” power for offices and datacenters.

Source: Apple Energy gets federal approval to sell power into wholesale markets

Freeze in Oil Production? Not buying it.

While on Mornings with Maria, we talked about the agreement between members of OPEC and Saudi Arabia to freeze oil production at January 2016 levels.

First off, I am highly skeptical that this freeze will stick. Historically any cuts, and this isn’t even a cut, have been rather notoriously violated, with quite a few such “cut” announcements necessary to get anywhere near stability in oil prices.

With the proxy war between Saudi Arabia and Russian ongoing in Syria and OPEC’s understandable desire to significantly knock back production by frackers, coupled with Iran’s new ability to sell on the global markets, there are entirely too many reason to keep pumping. I suspect we won’t see much stability in prices until a materially amount of production capacity is taken offline with the associated defaults and bankruptcies.



Ukraine – Why and What’s Next

Ukraine – Why and What’s Next

As if things in Europe aren’t complicated enough, the situation in Ukraine is getting more troubling by the day. The turmoil there is having vast geopolitical impacts that are keeping the investing world as nervous as a long-tailed cat in a room full of rocking chairs. Here’s the quick, errrrhhh, fair enough, as quick as a verbose Irish lass can get, version of how we got to today.


In late 2013, Ukrainian President Viktor Yanukovich was expected to sign some agreements that could eventually integrate Ukraine with the European Union economically. Ultimately, he refused to sign the agreements, a decision thousands of his countrymen immediately protested. Demonstrations eventually broke out with protesters calling for political change. When Yanukovich resisted their calls, they demanded new elections. Eventually the protestors won, Yanukovich was forced to flee the country and now we have a nation in flux.


So why does anyone outside of Ukraine, population 44.6m and with 233k square miles, care? Ukraine is central to Russian defenses, sharing a long border with the former Soviet Union and more importantly, Moscow sits all of 300 flat and easily traversed miles from Ukraine. Therefore, from a Russian perspective a tighter Ukrainian-EU integration represents a threat to Russian national security. Putin appears to be disinterested in actually governing Ukraine, but rather his goal seems to be to effectively have negative control, the ability to prevent Ukraine from doing anything Russia dislikes. With that in mind, it appears that even the very idea of further EU integration was provocation enough for Putin. The European Union’s and the Germans’ public support for opponents of Yanukovich crossed his red line.


From a European perspective, Ukraine isn’t quite as interesting. Economically the Eurozone wasn’t enamored with having the nation join the EU, it just liked the possibility of such. Adding a country as weak and disheveled as Ukraine to an already strained union didn’t make much sense, but the idea of the possibility someday is attractive. The talk about joining was really more about inviting Ukraine to make a cultural shift towards Europeanism, with a constitutional democracy and a more liberalized economy. Germany found itself between the proverbial rock and a hard place as it continues to work with Russia on its mutual energy and investment interests while trying to manage coalitions within the European Union, particularly attempting to appease the Baltic States and Poland who would like to see Ukraine closer to them and further from the Russian camp, giving them an additional buffer.


The U.S. strongly supported the Orange (anti-Yanukovich) Revolution, siding with the Germans and the Eurozone, which was no doubt going to get under Putin’s skin; but then the U.S. owed him one after the Snowden situation. Throughout history, many of the global conflicts, and for that matter noteworthy familial brawls, have been catalyzed by the little things.


The situation has evolved into a tense standoff between the G7 nations and Russia. On March 12th, the U.S. Department of Energy announced that it would draw down from the U.S. Strategic Petroleum Reserve in what it claimed was a “test sale to check the operational capabilities of system infrastructure.” In reality, this was a warning shot fired at Putin. Later that same day Bloomberg reported that the U.S. has escalated the situation even further, with General Martin Dempsey, the Chairman of the Joint Chiefs of Staff, claiming that “in the case of an escalation of unrest in Crimea, the U.S. Army is ready to back up Ukraine and its allies in Europe with military action.” The G7 has threatened sanctions against Russia if it continues, with the U.S. Congress passing a resolution on March 11th to work with European allies and others to “impose visa, financial, trade and other sanctions” against key Russian officials, banks, businesses and state agencies. In a quick tit-for-tat, Russia responded on March 13th that it is prepared to retaliate with sanctions of its own against the west. Germany responded to this by announced that Angela Merkel is prepared to cancel a summit with Russia if Moscow does not help to defuse the situation.


To add a little extra flame to the fire, Iranian Oil Minister  arrived in Moscow late March 13th to meet with Russian Energy Minister Alexander Novak and Deputy Prime Minister Igor Shuvalov, IRNA reported. Namdar-Zanganeh will discuss ways to deepen economic cooperation between the countries, because there weren’t nearly enough strained relationships!


Militarily things are also nail-biter as around midnight on March 5th the Russian navy used tugboats to maneuver a 9,000-ton hulk of a mothballed anti-submarine cruiser into the inlet to Crimea’s Donuzlav Lake, effectively blocking access to the sea from Ukraine’s primary naval installation on the peninsula. Reportedly seven of the Ukrainian’s twenty five ships are trapped, picture at left.


According to the Ukrainian Defense Ministry, on Saturday March 15th, Ukrainian forces repelled an attempt by Russian troops to land in the southern Ukrainian region of Kherson Oblast. The landing reportedly occurred on Arbatskaya Strelka, a long spit of land running parallel to the east of Crimea. Earlier, it was reported that four Russian military helicopters deployed around 60 Russian troops near the town of Strilkove, forcing around 20 Ukrainian border guards and servicemen to retreat from their positions. Later in the day Ukrainian and Russian defense ministries announced a truce in Crimea until March 21st. Anyone else feel like renting Red Dawn (the original of course)?

On Sunday March 16th, the people in the Crimean region reportedly voted to have Russia annex Crimea by an overwhelming majority of some 95%+. On Monday the EU announced that it would impose travel bans and asset freezes on 21 Russian and Ukrainian officials that are considered central to Crimea’s move to separate from the Ukraine. The U.S. issued sanctions as well, via an executive order signed by the President, to freeze the assets of and ban visas for seven Russian officials and four Ukrainians.


Tuesday the Kremlin announced that it had officially annexed Crimea, which could be the most dangerous geopolitical event of the post-Cold World era. The two most likely outcomes are:

  1. Russia will quickly prevail, gaining the power to redraw its borders and set the precedent for exercising veto powers over the governments of its neighbors or,
  2. Western-backed Ukrainian government will push back and the second-largest country by area in Europe will descend into a Yugoslav-style civil war that will likely pull into its turmoil, Poland, NATO and eventually the U.S.


An alternative outcome is unlikely as Putin cannot at this point give up Crimea. It would mean a publicly shaming on a global level that could destroy his presidency.


Bottom Line: This situation has the potential to rock the markets, which are for now keeping a wary eye. Europe desperately needs Russian fuel. London and much of Europe is greatly beholden to the nouveau riche Russians for their highly demonstrative consumption of luxury goods and services, which only adds more pressure. There’s even a reality TV show called “Meet the Russians” which follows the lives of some ultra-bling Russians who are buying up Britain and “setting a new benchmark for extravagant living.” Europe can’t afford to push too hard back against Russia, but they also cannot ignore a precedent for unfettered Russian aggression. It is impossible to predict exactly how this will play out, but close attention is warranted.

November Economic Indicators

November Economic Indicators

The market has been on a tear, so what do November’s economic indicators tell us?

J GDP beats: On November 7th we learned that 3rd quarter GDP was better than expected at 2.8%, which of course pushed stocks lower in today’s good is bad and bad is good upside down market.

K Unemployment beats, but in lower paying sectors. On November 8th the U.S. Bureau of Labor Statistics reported that, “Total nonfarm payroll employment rose by 204,000 in October, and the unemployment rate was little changed at 7.3 percent. Employment increased in leisure and hospitality, retail trade, professional and technical services, manufacturing, and health care.” Later in the day CNBC reported, “Breaking (11:32AM EST) Europe stocks close lower after US jobs data.” Remember, good news is bad news these days.

J Mortgage delinquency improves: The delinquency rate declines 2.8% in October for mortgages according to Lender Processing Services, making October 2013 10.7% lower than the same period last year. The number of homes entering foreclosure is also down 30% compared to a year ago.

K Borrowing returns: The deleveraging cycle in the U.S. appears to have bottomed out, with household debt rising $127 billion in Q3 to $11.28 trillion, which was the largest increase since the first quarter of 2008. Mortgage balances increased $56 billion and auto loans $31 billion, giving Detroit more cause for optimism. Investment-grade U.S. companies have issued a record of over $1 trillion in bonds so far this year. Keep in mind though as borrowing accelerates, all those bank excess reserves sitting at the Federal Reserve (see chart below) may make their way into the economy, which could result in inflation when the total stock of money in the economy jumps.



K The European Central Bank cut its benchmark interest rate to a record low of 0.25% from 0.5% on November 7th, moving more quickly than expected to stimulate the euro zone economy in the face of falling inflation. Inflation in the euro zone unexpectedly declined to an annual rate of 0.7% in October, well below the E.C.B.’s official target of about 2%, raising concerns of deflation, which many believe would be harmful to the economy.

L Germany’s economy is continuing to improve, while concerns are growing that France may be heading back into a recession and Italy is still floundering. The latter two are unsurprising since much of their economic malaise can be traced to fundamental fiscal problems such as labor laws that make it risky to hire new employees since letting them go (perhaps because they don’t work out or the business doesn’t grow as much as was expected) is frightfully difficult. Many businesses just don’t want to take the risk. Add to that a mountain of red tape that make starting and growing a business attractive only to those who enjoy the idea of continually pounding their head against the wall.

K China appears to still be in expansion mode, but is slowing. Japan’s economy seems to be responding well at the moment to its Central Bank’s policy of continual monetary loosening, with exports posting their largest gain in three years. Looks good for now, but give me a few cups of coffee and a cupcake or two and my engines get revving like nobody’s business. What serves as a kick start can end in an angry digestion and a cranky post-sugar high.

L Emerging market stocks are struggling as whispers of taper talk continue to linger, bringing to mind Don Coxe’s observation that, “Emerging markets are markets you can’t emerge from in an emergency.” Still wary from the last market crash, investors seem to be seeking areas where they think they can escape quickly if there is a rush for the exits. However, emerging market equities are currently priced at more attractive valuations than their developed world counterparts.

J U.S. energy sector rising: Petroleum exports as of July, according to the U.S. Commerce Department, are up 11% year-over-year, which is nearly 10 times the pace of total exports. Imports of petroleum products have dropped 6% year-over-year, which puts the nation back to mid-1990s levels. Oil related imports are now at a record low of 10% of all imports, compared to 12% last year and 15% five years ago.

Not out of the woods yet with the economy

Not out of the woods yet with the economy

The Economy

While the domestic economy is strengthening a bit, the recent unemployment numbers greatly overstate the improvement as most of the gains simply came from people leaving the workforce rather than actual employment gains.  At Meritas, we mostly ignore the unemployment numbers and look simply at Civilian Employment as a Percentage of the Population.  This number remained unchanged from December and has only increased 0.2% from January of 2011 and is currently 58.5% after having bottomed out at 58.2% Dec of 2009.  We are only up 0.3% since the bottom of the employment market!  Employment numbers alone don’t tell the whole story – we have to also look at income levels.  Real household income, meaning income adjusted for inflation, was $55,962 in January 2000.  At the end of the recession it had fallen to $53,638.  It is now $50,876.  In twelve years it has fallen over 9%.  On top of that households are saddled with unprecedented levels of debt.  For decades the average household income to debt ratio was about 65%.  It peaked at 140% in 2007 and is now just below 120%.  Falling incomes and the need to reduce debt don’t make for much of an economic tailwind.

As for Commodities

The price for commodities is really a function of two things:  the supply vs. demand for the commodity and the strength of the dollar.  Most commodities, with the exception of natural gas and crude oil are over-bought today, we believe on the false assumption that the European situation is going to be well controlled and that we are economically out of the woods.  The Baltic Dry Index, which is a measure of commodity shipping costs, advanced from a 25 year low for the first time since Dec 12th, after falling rates boosted the number of dry-bulk owners dropping anchor and refusing to hire.  Rates are near or below cash break-even for every vessel class, so we are starting to see more ships anchoring and refusing to trade.  The index is down 62.8% YTD and 38.1% Year-over-Year.  We just saw how little pricing power there is in the market as P&G was forced to roll back prices after an 8% increase cost them 7% of market share.

Gold is trading more as a currency than a commodity these days.  It is a hedge against the loose monetary policy arising from pressures caused by too much debt.  Gold isn’t really going up so much as fiat currencies are being devalued.  Speculators have increased their holdings of gold for four consecutive weeks. Possibly in response to the European sovereign debt crisis and indications from the Fed to expect continued loose monetary policy.  During the last reporting period net purchases were over 33k, brining the net long position to 188k contracts.  Non -commercial energy product accounts failed to increase their holdings of oil after the Fed conference, selling 4,500 contracts on a net basis, reducing the net long positions to just over 300k positions.  This is just 0.1 Standard Deviation below the one-year average.  Copper is clearly driven by what happens in China and there are a lot of concerns about what could happen there this year.  The IMF reported that China’s growth would be cut in half from a projected 8.2% in 2012 if Europe’s debt crisis worsens.  In defense against this, China will likely continue to ease up on their monetary policy, which will push the Shanghai Stock market index up and provide a tailwind to copper.

Food commodities down YoY

  • Corn down 4.5% up 0.2% YTD
  • Coffee down 13.9% down 5.3% YTD
  • Sugar down 25.9% up 3.9% YTD


  • Aluminum down 12.0% up 10.8% YTD
  • Copper down 15.7%% up 12.4% YTD
  • Gold up 27.4% up 9.6%
  • Silver up 15% up 19.9%


    • Brent up 14.1% up 6.1% YTD
    • Gasoline up 19%% up 7.9% YTD
    • Natural Gas up 19% up 7.9% YTD
    • Natural Gas down 41.1% down 15%

A View on Food, Energy and China

A View on Food, Energy and China

We’ve seen energy prices spike recently, leaving many, including yours truly, grumbling disdainfully while trying to avoid inhaling that ever-lovely, wafting eau-de-pump, watching the dollars rack up to a mind-boggling level as my voracious SUV sucks down another pocket-full with a grating “ping” as its thirst is finally satiated.  (Throwing a little literary flair in this morning!)  We are seeing some downward pressures on oil prices and many argue that we are in for a significant down-turn.  At Meritas, we don’t attempt to time short-term market fluctuations believing that is more appropriate for those who head to Vegas for the weekend.  We do however, look at longer-term trends and build investment strategies around those.  When it comes to energy, the trends are pretty clear.  While the demand from the developed world is not expected to go through the roof in the future, as emerging markets significantly increase their level of affluence, their demand will rise dramatically and given the size of the populations we are dealing with, this will be impactful.  (See Chart below, source:  FactSet, BP Statistical Review of World Energy as of 12/31/2010)

This should come as no surprise given the shift in growth from the advanced economies to the emerging markets, with emerging and developing economies posting strong growth while advanced economies languish.

REAL GDP (Quarterly % Change from Year Earlier)

Since 2001, the average real GDP growth rate in the emerging markets was 6.3% year-over-year while in the developed world only 1.9% year-over-year.  In the 10 years prior to this, emerging markets averaged 3.7% vs. 2.0% for developed markets.

We are carefully watching for a potentially “hard landing” in China, which we believe to be more likely than not, but in the longer-term the global engine of growth lies more in the emerging markets than in the developed.   Additionally, the U.S. Energy Information Administration is expecting significant increases in coal demand from China, which could be quite beneficial for the U.S. as we produce about 35% of the world’s coal supply.

Additionally China’s policy of being agriculturally self-sufficient is not sustainable given it has 22% of the world’s population, only 6% of the world’s arable land and water resources per person on par with India’s (and that water is high polluted) with a population increasing its demand for more inefficient proteins such as beef.  (Chart below from GaveKal)

However, this isn’t a simple story as China has benefited from a policy similar to the “Bernanke put” in the form of a “Wen Jiabao put” whereby when growth dropped below 8%, the government stepped in to get the economy moving again by either squeezing more productivity out of its worker and/or increasing debt.  Today those aren’t viable options as a debt cannot be increased much with an already existing inflation problem and workers cannot be squeezed further.  If China wants to continue its 7-8% growth, it will need to reduce local governments’ use of debt to cover fiscal deficits, improve the efficiency of its capital markets through significant financial reports and allow the economy to shift towards the service sector to unlock new sources of productive growth.