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Loosing trust in SaaS, at least for startups

Late last month it was announced Facebook would be shutting down Parse.  This came as a surprise from many as there wasn’t any indication Facebook was planning to change direction for Parse.  Looking at the decision in more detail makes sense however as Facebook is moving to consolidate around its own ecosystem instead of enabling other external apps.  This aside, one of the interesting developments is Parse has given users until January 28th 2017 to migrate off their services, an uncharacteristically long amount of time.  Parse even went the next mile and open sourced a Parse compatible API on Github.  This contrasted with news this week that Palantir acquired Kimono.  Instead of giving users a year to migrate to another platform, Kimono announced service would be suspended by the end of the month – just about two weeks before their service would become unavailable.  Furthermore no part of their product was open sourced or alternatives provided for their current customers.

We’ve seen this happen over and over – smaller SaaS startups get acquired or fold leaving their customers searching for an alternative, many times with little time to make a transition.  Their existence is becoming increasingly ephemeral and many times customers have little or no warning before the rug is pulled out from underneath them.  This forces companies who used those services to invest time and energy to find alternative services instead of continuing to develop their core product.  For SaaS products like Kimono and Parse, the advantages they bring has always been being able to leverage SaaS within a technology stack to more quickly develop and implement a product.  This is critical when attempting to scale and develop a product in such a fast pace iterative environment like tech.  However the disadvantages of relying on a SaaS startup is significant and grow as the product matures and user base increases.  Irregardless of industry standard integration modalities and distributed computing, there is never a 1 for 1 SaaS replacement and functionality can vary greatly.  The cost of replacing a specialized SaaS product can be significant especially when attempting to migrate within 2 weeks.

There are about a dozen other services that have similar capabilities that Kimono had. But will companies be willing to invest in a transition, if the same scenario will play out again in 6 months?  Startup SaaS companies are going to have an increasingly difficult time finding new enterprise customers with the current trend, which is ironic since their end goal is most often to be acquired.  Not to mention if not acquired typically these startups have a limited runway, meaning if they don’t reach break even they’ll risk shutting down again abandoning their customers.  The industry is going to start to shift to a position of stability, looking for SaaS services from established companies or leveraging the cloud to host their own technology stacks within their control.

Signs of market stabilization… for now…

2016 has started off with severe volatility in the financial markets.   The downturn in Chinese equities has led to global contagion as the Shanghai Composite had two trading days end closed 7% limit down and forced Chinese financial regulators to dispose of their circuit breaker policy.  Additionally, the S&P has experienced the worst calendar year start ever.  With so much uncertainty about future market direction, GFC would like to highlight some interesting market divergences that may point to signs of stabilization over the short term.

Last week saw a dramatic intraday reversal on Wednesday with Dow Jones Industiral  Average losing 538 points intraday.  During the midst of the selloff, the advance/decline ratio registered .0333 meaning that there were 30 stocks down for every 1 up.  However, by the end of the day, the market recover to only lose about 250 points with an A/D ratio of .40 meaning there were only 2.5 stocks down for every 1 up.  It was quite an intraday shift in momentum as many stocks experienced significant intraday reversals.  The rest of a the week continued bullish with the market forming a fairly compelling reversal on the weekly candle.   (see chart below)


The market reached very oversold levels last week and was due for a short term rebound.  Whether or not this bounce has legs remains to be seen.  GFC is of the belief that additional downside risk at this time is significant, and advise that speculators sell into strength should it manifest.   The Daily Moving averages are confirming that a bear trend is in motion as the market is trading below the 50 DMA which is currently trending below the 200 DMA.  Should the market rally to the 1925-1950 area GFC is prepared to enter into short positions.25JAN16-2

Another interesting divergence that we noticed last week was that the VIX was not registering the type of volatility normally present during a panic.  Despite rather severe selling pressure which carved out lower lows in the markets, the VIX was unable to eclipse the high it made during last summer’s selloff when it peaked on August 24th.  This was a warning sign that the market was likely to stabilize in the short term which it did.    (See chart below)25JAN16-3

Another interesting and most unusual divergence that has been occurring lately is that of the performance of the U.S. Dollar in the Spot FX markets compared to the performance of U.S. treasury bonds.  This divergence has been occurring since early December when the dollar shorts covered their positions on December 3rd.  Since that time the EURUSD pair, the largest (47% weighting) component of the U.S. dollar Index, has generally been trading with a 150 pip range of the 1.09 level.  GFC finds this interesting because while global equity markets have been selling off, the U.S. bond market has experienced a significant flight to safety bid.  On December 3rd, the 10-year U.S. Treasury bond was trading with a yield of 2.33%.  Over  the past 2 months, yields have declined to  2% even where they are trading today.  Normally when the bond market receives a safety bid like this, so does the US dollar in the FX markets.  However this has not happened.  The dollar has failed to rally against other major currencies.  What makes this even more intriguing is that last week the ECB President Mario Draghi alluded to the possibility of additional QE measure for the Eurozone.  GFC is surprised the US dollar didn’t have more of an FX rally than in did in the wake of this news which signaled a major diverging between U.S. and EU monetary policy.

Usually the bond market leads and other asset classes follow, so if the smart money is right, we should soon see the U.S. dollar begin to rally substantially in the FX markets.  A closing above 100 on a weekly basis for the USDX will signal further dollar strength lies immediately ahead.    Additionally, a closing below 1.0710 on a daily basis in EURUSD will signal additional weakness for the pair.

Why Boeing actually cut 747-800 production

This past week Boeing announced they would be cutting their 747-800 production down to .5 frames per month.  For many analysts this came as no surprise – the latest jumbo jet has failed to gain traction since its EIS in 2011.  Even in the cargo market where it seemed to have a sweet spot with its adaptable cargo capabilities, adoption has not been anywhere near where Boeing would like.  In their press release Boeing cited a cooling cargo market for the lack of demand.  According to the Bureau of Transportation Statistics, cargo volumes are up by 1.35% YTD since October 2015.  Additionally the GFC FedEx Cargo index shows high utilization over this past holiday season and continued robust aircraft utilization into early this year. Although this doesn’t suggest significant growth in the air cargo market it suggests there might be more reasons for the 747-800’s poor sales performance.


FedEx Cargo Utilization (min/day/frame)


Existing cargo aircraft and low oil prices

This is easily the largest contributor to Boeing’s woes. Although Boeing won’t admit it, with oil at ~$30bbl levels, cargo airlines are flying with their existing fleet longer and foregoing costly upgrades.  Furthermore, there is ample market for used frames, including 747-400F and other variants.  Cargo airlines like Kalitta are even keeping their 747-200s in service longer, along with 747-400BCFs of which there are plenty of used frames available.  As passenger airlines upgrade their fleet, used aircraft such as 767s and 757s are also becoming increasingly abundant.  Boeing recently announced a program for conversion of 737-800 passenger aircraft as well.  Freighter conversion programs allow cargo airlines to take advantage of these used aircraft and provide options for lower capital costs as opposed to newly-built aircraft.  Declining oil prices make this option even more attractive.  With a list price of $378.5 million for a new 747-800F and interest rates now rising, the choice to purchase used aircraft is logical.

Belly cargo is taking up cargo slack

Over the past decade, many passenger airlines which historically had separate cargo operations have consolidated their cargo operations and mostly reduced or eliminated cargo-specific aircraft from their fleet.  A good example of this model was Northwest Airlines, which at its peak had a fleet of 15 747-200Fs.  After Delta merged with Northwest, Delta eliminated these aircraft in 2009 and consolidated all cargo operation to lower deck cargo on passenger aircraft.  Japan Airlines has gone through a similar process and eliminated its dedicated cargo aircraft in 2010.

The reason for this shift is in part due to the increasing capacity of lower level cargo on new airliners.  Aircraft of the 60s, 70s and 80s were not as adept as aircraft are today for carrying ancillary cargo.  The Boeing 707 and DC-8, popular narrow body aircraft of the time, did not have the cargo capacity of today’s long haul aircraft.  These aircraft were designed in a way which did not facilitate the use of Unit Load Device (ULDs) that had been standardized for new larger wide body aircraft such as the 747.  Even as wide body aircraft started to take hold, their cargo capacities were limited and not optimized for carrying additional cargo.  Some airlines did opt for “combi” versions which could carry cargo on the main deck of the aircraft, however none of these aircraft gained wide adoption.  Compounded by the scheduling requirements of passenger aircraft and the cheap price of oil a the time, it was easier for airlines to augment their cargo capabilities with additional cargo specific aircraft.  


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Cross section of an A300 with 2 LD3 containers left and a 737 right, similar to a 707 cross section


As demand for air freight picked up in the late 80s and 90s, dedicated cargo airlines utilizing jet aircraft started to spring up and passenger airlines continued to add cargo aircraft to their fleet, sometimes using their old passenger aircraft and converting them to freighter use.  The shift to consolidate cargo operations for passenger airlines started with the introduction of aircraft like the 777 in the mid 90s.  The 777-300, the largest twin engine passenger aircraft to date, has the capability to transport 44 LD3 containers in its lower holds.  Compare this to the L-1011, an early wide body aircraft, the 777-300 can carry nearly three times as much cargo.  This capability came with the advantage of only using two engines and a much greater fuel efficiency.  Increased range and other efficiencies also allowed passenger airlines to more fully utilize the aircraft they had by adding more cargo to existing flights.  Today it’s estimated nearly 50% of air cargo is from lower hold cargo.

Air freight is unique

Coinciding with the increased capabilities of newer passenger aircraft was older passenger aircraft that were being replaced.  Aircraft like the MD-11 and the A300 became a popular conversion with cargo airlines as the aircraft were modern and relatively cheap on the used market and provided incredible cargo capabilities.  

Large newly-built freighter aircraft like the Boeing 747 did find their niche in the market.  Dedicated cargo carriers like UPS, Fedex, TNT, and DHL found roles for large wide body aircraft hub to hub routes.  The Boeing 747 especially has dominated the cargo market, with over 200 in service carrying nearly half of the world’s air freight.  Airbus wanted to break into this market of larger freighters and launched the A380F as an option to usurp the 747, promising 7% greater payload capacity over its competitor.  Although the A380F gained 27 orders, they were all canceled or converted by 2007.  This lack of expected growth shows the market for large freighter aircraft simply isn’t that large and highlights the issues with aircraft of this size.

As air freight evolved so did the competition.  Cargo carriers started competing not only on price but also on delivery time, especially as sea cargo drove price down.  Because of this, frequency has become a priority over capacity for most air freight routes.  Air cargo operators can’t afford to sit around and wait until they have enough cargo to fill an aircraft, or only provide air freight services a few days out of the week.  They benefit much more from the flexibility to dynamically route aircraft based on demand than fly half empty aircraft part of the time.  Few point-to-point destinations are large enough in cargo volume to justify volumes that fill a 747 on a daily basis.  Furthermore, new freighter aircraft like the 777F have the same cargo capacity of the older 747-200F.  The dynamics of the air cargo markets today simply doesn’t fit well with large aircraft such as the 747-800F except on very select routes.

The future of air cargo demand still remains unclear, however in the short term its apparent aircraft like the 747-800F have limited application.  With no other large freighter on the drawing board it might be a while until we start to see a “clean sheet” designed cargo aircraft.  As current passenger A380s start being retired it is possible we’ll see a freighter conversion program which involves strengthening the cabin floors for greater cargo flexibility.  But the future for air cargo seems to be centered around medium narrow body aircraft conversions like the 737 and other wide body aircraft like the 767 or 777.

The shadow war for natural resources

It might seem odd that during a time where nearly all commodities have seen double-digit declines in the past year there is an underlying push for investment and consolidation of these resources.  It’s no secret OPEC has fought to drive out US shale oil producers by flooding the market with supply, depressing oil prices down to 12-year lows.  But it seems consolidation is happening for other commodities as well.  As we shift away from fossil fuels, other finite resources are taking their place such as rare earth metals, which are integral in technologies like renewable energy.  Lithium cobalt oxide, derived from lithium carbonate, has become a crucial component in nearly every electronic device we own as it is a primary ingredient in lithium-ion battery technology.  Now lithium-ion batteries are finding their way into durable goods such as cars and home power systems, and even into industrial applications supplying energy storage for renewable energy resources.  Companies and countries are taking note of this shift, and some have already started to move on controlling as much of these resources as possible.


One timely example of this is trend is Lithium carbonate production consolidation.  The Economist recently reported Lithium carbonate spot prices have soared in recent months to over $13,000 a tonne, doubling from 2014 prices.  In 2015 Albemarle, the world’s largest Lithium producer, completed the purchase of Rockwood, which owns Chile’s second largest lithium deposit.  The acquisition valued at $6.2 billion, secured Albemarle as the leading producer of lithium products, including lithium salts and metals critical for lithium-ion battery production.  Recently, shares of Sociedad Química & Minera de Chile SA (SAC) surged after it was reported Citic Securities Co., a Chinese firm, was interested in purchasing a stake in the company.  Just weeks prior, Citic invested $60 million in FDG Electric Vehicles, another Hong Kong-based company planning on expanding its manufacturing capacity of lithium-ion batteries for buses it plans to build.

This news isn’t shaping up well for companies such as Tesla which depend on lithium-ion battery technology. A majority of the cost for Tesla’s cars is the battery pack. A rise in lithium prices makes the manufacturer vulnerable, especially when it does not own a company directly involved in lithium production.  Although Tesla has penned agreements with a number of producers, including a local startup in Nevada, the car maker will still be exposed to fluctuating lithium prices as supplies continue to consolidate.

Although other commodities such as rare earth metals are also on decline, their output is still largely controlled by China.  In 2008 and 2009 prices for raw materials such as polysilicon, used for the manufacture of photovoltaic (PV) cells, skyrocketed.  Other rare earth metals experienced similar trends during this same time period.  These commodities saw such a drastic price increase because China, a primary producer, enforced export controls and other measures in an attempt to encourage manufacturing locally.  This tactic backfired and these export controls were later relaxed after the 2008 recession.  China then tried another tactic: just as OPEC flooded the market with cheap oil to drive out US shale producers, China also began to flood the market with rare earth metals.  The result has successfully depressed commodity prices, incentivised manufacturers to incorporate and become dependent on these cheap resources, and drive out US producers who can’t withstand sustained lower prices making production unprofitable.  Molycorp, which mines rare earth metals in California, filed for bankruptcy in June of 2015 citing lower prices.  Other producers will soon follow as they are unable to sustain unprofitable mining operations over an extended period of time.

With China still controlling about 95% of global rare earth production, this trend continues to be a risk.  As technology continues to become more reliant on these commodities and the US and other countries start to develop and manufacture locally, China might once again step in to curtail its exports once US producers and others are gone, again increasing prices.  Tesla and other manufacturers are incredibly vulnerable when critical components for their products are derived from materials controlled by only a few entities and cartels.  We’re already seeing this play out with Lithium prices.  The consolidation of Lithium producers has coincided with a drastic increase in price.  Despite the US dollar index at all-time highs and other commodities at all-time lows, lithium has defied this trend and producers are positioning themselves to profit and control as much of the rare earth commodities as they can.

A look back at 2015

2015 was an exciting year for GFC and for the financial markets in general.  We covered a number of topics including the following articles which proved to be especially relevant:

Tech fatigue:  As with any new Apple device, analysts were anticipating record sales and the possibility of the next iPhone type device.  However the smartwatch in general never seemed to catch on as widely as analysts had expected.  Apple hasn’t even released sales figures for the apple watch, and by some estimates only comprise %3 of the total iPhone user base.

Valley of the kings:  2015 turned out to be subdued in terms of IPOs, as tech companies looking to cash in on their sky high valuations had to take a second look at their prospects.  Theranos is an excellent example faltering after their blood tests came under the scrutiny of the FDA.  Others are scaling back their valuations as investors take a hard look at the reality of the marketplace and revenue potential.

Rally like its 1999:  Across the board the equities market was either flat or in the red for major indices.  As 2016 kicks off the markets have extended this decline well below the highs of the NASDAQ made in 2015.

Tesla’s numbers don’t add up:  Since our article was published Tesla stock has continued to fall.  Other bad news has come out as well, such as reports suggesting that two-thirds of Tesla Model S owners needed an entire new drivetrain by 60,000 miles.  Consumer reports also revised its original assessment of the Model S, highlighting a number of defects and fixes.  For its new Model X, Tesla came in on the lower end for its own estimated deliveries at 17,400 cars.

High aircraft utilization translates to robust on-line shipping:  As our data showed from our proprietary cargo utilization index, on-line holiday spending was robust while in store spending was stagnant.  Shippers experienced increased volumes from on-line purchases.

In review: The Big Short

The New York Times Best Seller “The Big Short: Inside the Doomsday Machine” by Michael Lewis hit theaters last month with much anticipation and populist acclaim from Hollywood.  GFC would like to provide a subjective review of the film for our readers who, have most likely either read the book or, are at least intimately familiar with the storyline of the financial crisis of 2008.

Let us start by saying this is easily the best financial film since Margin Call starring Kevin Spacey debuted in 2011. (For those of you wondering where Wolf of Wall Street ranks in our hierarchy of financial flicks, just know we regard that movie as a sad and debauched production with very little substantive content to qualify itself as a legitimate Wall Street Classic)  With that being said, The Big Short is a very captivating story which  provides great insight to the real stories of the people who not only saw the crisis coming, but had the wisdom and the fortitude to bet against the U.S. housing market and profit handsomely by doing so.

The story primarily revolves around 3 people, Greg Lippmann, a CDO trader at Deutsche Bank who was intimately familiar with the toxic mortgage backed securities his desk was packaging and selling, Steve Eisman, a outspoken hedge fund manager, around Dr. Michael Burry, a former neurology specialist turned Portfolio Manager at Scion Investments Inc.  The story tracks how these people were among the first to recognized serious trouble on the horizon and details their creative and heroic trading exploits as they were able to capitalize on the greatest financial crisis since the Great Depression.

For the average American, who is still grappling with understanding how the housing crisis nearly bankrupted the entire U.S. financial system, The Big Short should be required viewing in order to gain a basic understanding.  The movie does a great job explaining the origin and evolution of complex financial instruments such as Mortgage Backed Securities (MBS) Collateralized Debt Obligations (CDO) and Credit Default Swaps (CDS).  The movie dumbs these concepts down as much as possible and even provided cameo roles to random celebrities who explained these synthetic financial instruments with creative abstractions in order to hold the attention of the financially illiterate.

Despite showcasing an all-star Hollywood cast consisting of Brad Pitt, Ryan Gosling Christian Bale, and Steve Carrell, the true populist attraction of this film emanates from America’s feelings of antipathy towards Wall Street bankers in the wake of the financial crisis.  It’s easy to envision many young females buying tickets to this movie because of the Hollywood heartthrob cast, and then watching the screen as the entire plot flies over their head.  Only an intellectual audience is fully capable of appreciating this movie.

As a financial professional, one of the key takeaways for me was recognizing how complex the trades these guys were putting on actually were.  It’s important to know that up until 2005, the market for mortgage backed securities was a one way market.  Long only.  Dr. Michael Burry had learned about the fledging credit default swap market and literally had to petition the big banks to allow him to buy credit default swaps on specific mortgage bonds he knew were likely to default.  They reluctantly agreed to create a new CDS market for him and at first were happy to sell him default insurance and initially charged him basis point premiums which were essentially the cost equivalent of insuring AAA rated bonds.   He was one smart cookie to not only recognize that the MBS market was going to fail spectacularly, but he got into the trade so early, that the banks were willing to make an entirely new CDS market for shorting subprime mortgage bonds, which they only agreed to because in their minds he was buying insurance for the end of the world.

Another aspect of the storyline that could have been emphasized a bit more, was that after throughout 2006 and 2007 as adjustable rate mortgages were being reset higher and mortgage delinquencies began to rise dramatically, the banks were not properly adjusting the value of the speculative positions in their CDS markets.  Consequently, people like Michael Burry and Steve Eisman were being forced to pay additional insurance premiums on their CDS positions because the banks were not marking the value of their MBS bonds to market. The large Wall Street banks had assigned artificially high values that their optimistic MBS pricing models were projecting irregardless of the actual economic performance of those bonds.  The movie could have done a better job highlighting the key importance as well as the key legal battles that were waged over the importance of mark-to-market accounting during and after the crisis.  Nevertheless, the movie revealed how the tension stemming from bank reluctancy to mark down the value of their CDO & MBS securities directly led to undue financial stress for the people who got it right and correctly bet against such instruments.  One can only imagine the agony of being 110% correct and having to fork over another monthly CDS insurance premium in the tens of millions of dollars each month, knowing #1) that the banks are defrauding you, #2) that you have to pacify investors who are going to wonder why your fund experienced another monthly drawdown, #3) that you have been 110% correct on the crisis and are losing money. Personal Note: During the Crisis, I was short many different banks stocks until the SEC banned the shorting of financial equities on Sept 19th 2008. On that day there was a massive artificially induced short covering rally with the  Dow Futures up over 600pts before the markets opened and I was subsequently forced to cover my positions at steep loss despite being 100% right about the solvency of the U.S. banking system.  My account was relatively small at the time as I was fresh out of college and only 22, however, the disgust and loathing the hedgefund managers in the film must have felt toward the big banks when they literally billions of dollars in the game can only be imagined.  

The final takeaway from this film that needs to be addressed fully is Hollywood’s exploitative demonization of Wall Street as well as the subtle narrative of class warfare this movie promotes.  Michael Lewis’s book was a great expose into how a small group of men who thought outside the box were able to identify and profit from a speculative mania. The main intention of the book was not to be a damning indictment of  banker corruption that contributed to the crisis, and even if it were, corruption within the banking system itself would be wholly inadequate.   Unfortunately for America, Wall Street, and audiences everywhere, the main takeaway from the The Big Short is a theme of banker corruption.


SPOILER ALERT:  The last scene of the movie offers a satirical ending with bankers being walked away in handcuffs as the narrator says:  “In the years that followed, 100’s of bankers and rating’s agency executives went to jail. The SEC was completely overhauled.  And Congress had no choice but to break up the big banks and regulate the mortgage and derivatives industries.  Just Kidding.”  For anyone who wasn’t asleep under a rock during and after the financial crisis, you know that’s not how the story ended at all, and therefore these satirical statements are more than a stupid joke, they are subtle exploitation of ignorance directed toward the type of people who know how their fantasy football team performed but couldn’t tell you what a bond is.  The satirical ending is meant to influence ignorant people into believing that banks going to jail is what should have happened and there is a deep wrong that injustice has been served Basically, the end of movie could instantly be transmuted into a Bernie Sanders class-warfare campaign video.   Deeper contemplation is needed to truly understand how the crisis happened.  The Big Short ultimately comes up drastically short of offering a comprehensive explanation of how and why the financial crisis occurred.

Prudent observers should ask themselves: “Why weren’t Wall Street bankers greedy and corrupt before the mid 2000s?  Why did the financial crisis happen when it did?   Mortgage Backed Securities have been around since the 1970s, why did it all blow up in 2008?”   To answer those questions one has to understand that the actions of bankers is largely dictated by monetary and regulatory incentives emanating from the Federal Reserve Bank, the U.S. Treasury, and Congress.  President Bill Clinton signing legislation which repealed the 1933 Glass-Steagal banking regulations was left out of the film entirely.  Additionally, a historical recap of the Federal Reserve’s interest rate policy decisions made by Alan Greenspan which lowered interest rates to 1% and incentivized loose lending practices by bankers after the dot-com bubble was conveniently omitted.  Also completely omitted were the roles played by Federal agencies such as Fannie Mae, Freddie Mac, and the Department of Housing and Urban Development (HUD) in which not only originated vast quantities of shitty mortgages but guaranteed them with a subtle tax-payer guarantee which eventually occurred to the tune of more than a trillion tax-payer dollars.

Was there fraud committed by bankers on Wall Street leading up to the financial crisis?  Undoubtedly there was, but it pales in comparison when compared to asinine legislative policy decisions propagated by the Federal government itself.  Ultimately the elected representatives of the American people voted to bail out the bankers with Secretary of the Treasury Hank Paulson and the Chairman of the Federal Reserve System Ben Bernanke imploring congress to bailout the financial system.  The satirical ending of this film insultingly assumes the American populous is just as dumb and ignorant after the crisis as there were before.    With all that being said, it worth remembering that Hollywood’s true motive is to sell movie tickets and entertain, not truly educate people.

Overall Rating: 5.5/10

Why package delivery drones are a long way off

Amazon announced with much fanfare in 2013 their intention to develop and launch a drone delivery service. Two years later, drones have bumped 3D printers out of the technological limelight. Drones already make scheduled deliveries: DHL employs them to deliver medication to a North Sea island. And now Amazon has released a new video showing their own drone transitioning from vertical to horizontal flight and successfully delivering a much-needed replacement soccer cleat, narrated by Jeremy Clarkson (who is known for his technical prowess).  From all appearances drones are well on their way to populating the skies of our neighborhood, buzzing about delivering our online purchases.  In reality however we are much further off than most would think.

There are a number of reasons the development of drones has taken off so rapidly in the past 5 years or so. Technology needed for drones has become cheaper and more accessible; microcontrollers such as the Raspberry Pi are now inexpensive but powerful. The explosion of the smartphone market has also allowed the mass production of miniature gyroscope devices, critical for drone stabilization and flight. Cameras have become lighter and higher quality, while lithium ion battery technology has become light and cheap enough to produce en masse. All these incremental technological improvements have allowed drone manufacturers to develop and produce consumer drones at a price within the reach of most individuals with some spare cash. The commercial application of drones is a natural progression. But are drones ready for unmanned high volume and large scale operations such as package delivery? Though possible in theory, there are a number of significant hurdles that need to be overcome in order for commercial drone delivery to be successful.

Weather is perhaps the biggest challenge facing commercial drone delivery. Commercial aviation has advanced to the point where aircraft are able to operate in most all weather conditions. Rain, sleet, snow, wind, cold; nearly all weather is safe for flying. But these capabilities are in part due to technology that does not translate to drones – for example, anti-icing capabilities. All commercial aircraft are equipped with ice protection systems of some type: either heating elements, bleed air, or mechanical ice boots which provide protection from ice build-up on critical flight surfaces.

G450 anti-ice bleed air system, not too complex

Drones do not currently have the capabilities to deal with ice accretion as current drone-sized batteries cannot provide sufficient power. Imagine if there was a snowstorm before the holiday season. Online shoppers relying on last-minute drone delivery would be unable to receive their purchases via drone. Uptime is especially critical for these types of last minute deliveries, if a package fails to be delivered on time customers are much more likely to simply drive to the nearest store rather than risk never getting the item they ordered. Even if a company like Amazon was to offer an alternative form of delivery as a contingency, the additional costs involved in maintaining not only a drone delivery fleet, but a traditional fleet of delivery vehicles as well or contracting with another company for same-day delivery, may prove too expensive.

Another environmental hurdle is wind. At the slow speeds drones can currently manage, sustained winds of 15-20 mph would significantly reduce their range or prohibit them from flying altogether. Current drone designs are optimized for vertical flight; most are not designed for high speed and efficient horizontal movement. Even when configured for horizontal flight, aircraft have complex systems designed to cope with a crosswind component. These systems, though complex, still require a human pilot to intervene in case an issue arises, something an unmanned drone will not have. Imagine a drone attempting to land to deliver a package on a windy day, in a yard covered by trees and flanked by power lines.

Typical suburban tree covered road

Visibility is frequently an issue with aviation in general. Complex systems of radar have been developed to help guide planes as they navigate the sky and land. Instrument landing systems (ILS) allow planes to hone in on a transponder signal to calculate the appropriate glide slope for a safe landing. CAT III-equipped airports and aircraft even can autoland without any pilot intervention, with visibility as low as 150ft. Delivery drones would have to contend with much more challenging conditions. Residential homes don’t have an ILS or localizer for a drone to track. Even with GPS capabilities, a drone will have to guide itself to a safe landing spot once it arrives on site. Amazon’s drone appears to use picture-type beacon to help guide drones to a safe landing spot. But how many people will know how to properly place these locators, not to mention a situation in typical urban and suburban areas which have tree cover, streetlights and electrical poles? Add in other environmental factors such as inclement weather and low visibility and the difficulties for drone operation seem outsized for their benefit.

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Low visibility landing conditions

Cargo capacity is another obvious issue. Battery technology still limits the amount of cargo a drone can carry due to the power density of lithium ion technology. There is a reason aircraft don’t run on battery power: pound for pound, lithium ion power density comes nowhere near Jet A. This will limit packages to a few pounds or less. A quick survey of my own Amazon purchases in the past year shows only a few packages would qualify. Package dimensions greatly limit drone usage as well. Even if a package remains within the required weight, it still has to fit within the cargo hold of a drone (Amazon’s appears to be about the size of a shoe box).

As drones begin to populate the skies, precautions need to also be put in place to prevent them from interfering with each other and other air traffic. Although the video does briefly reference these capabilities, no details are given. TCAS (Traffic collision avoidance systems) which are required on commercial aircraft, require both radar and transponders to operate. It an incredibly complex, standardized system, which plots the course of surrounding aircraft and calculates if a mid-air collision is imminent. A simple GPS-enabled reference is not effective in these scenarios, nor is a cellular internet connection robust enough for drones to communicate with one another. Equivalent systems need to be tested, standardized, and certified for drones.  Safety, especially when operating in low altitude in highly populated areas is critical.

Many comparisons have been made to commercial aviation, and despite technological advances, this past year 79% of flights arrived on time. Commercial aviation’s systems have taken decades to develop. Would drone delivery service succeed with only 79% of packages ordered delivered on time, not to mention the challenges above?

If all that were not enough, the continued controversy around the FAA and their approach thus far for drone regulation throws another wrench in the works. Policies around pilots needing licenses to operate drones, having drones always be within the operator’s sight, and other requirements seem draconian and uninformed. The simple fact is no one, including the FAA, has had to deal with drones until now. Technology has far surpassed the legislation needed to regulate their use (as is often the case), the FAA’s position is a cautious one which is expected when you’re dealing with aircraft regulation.

All this discussion is moot unless Amazon customers are willing to pay extra for drone delivery, and how much money Amazon is willing to spend to develop, implement, and maintain a fleet of delivery drones (not to mention the lobbying costs to change FAA regulations). It is still unclear how many online shoppers subscribe to Amazon Prime, estimates vary greatly however it’s speculated Amazon loses between $1 and $2 billion in shipping for Prime customers every year. Drone delivery will only increase this overhead. Even then the question remains: would a typical American family use drone delivery for the scenario laid out in Amazon’s most recent promotional video? I find this questionable at best. It would be much easier, less costly, and perhaps even quicker, to run down to the nearest shoe store and pick up another sports shoe rather than sit on your front lawn awkwardly waiting for a drone to perhaps arrive.  Drone delivery may soon go the way of the consumer 3D printer and might serve Amazon as PR stunt rather than a new form of delivery.

Dollar Currently at Significant Inflection Point

GFC wanted to post this update on the U.S. Dollar to alert our readers on a high probability trading opportunity.  Last week the dollar rallied on light volume through the holiday week to approach the previous 2015 high at 100.39.   This has many dollar bulls excited, however optimistic sentiment toward the buck seems to have reached an extreme with so many analysts expecting the dollar to continue to rally and achieve new highs for the year.

The current technical picture is sending strong caution signals to the bulls.  The first major factor the bulls must consider is the strong overhead resistance that prices are now confronting.  The high of the year which was achieve on March 13th, has not been tested since.   In March the dollar encountered substantial selling pressure as a year-long rally came to an abrupt end just above the 100 level.  Additionally, recent price action in November has seem diminishing returns in terms of both bullish momentum and price action.   While the US Dollar has been able to achieve a series of higher highs and higher lows this month and keep the bullish trend intact, it has done so at the expense of momentum as price action as devolved into a much slower-upward grind without much conviction.

Finally, during the recent rally of the past 5 weeks, the US Dollar has charted out a well defined internal trend line which initially acted as resistance and is now acting as support.  The dollar reacted to this line on 8 separate daily occasions, and therefore this trend line should be considered very important.  The current technical picture of the U.S. Dollar Index is provided below.


GFC believes that because of the tentative overlapping price action leading into a major area at 100.39, combined with waning price momentum, and a strong possibility of a break of a significant support trend line, the timing this week looks very ripe for a pullback in the US Dollar.  To take advantage of this pullback, it is helpful to look at the EURUSD currency pair which comprises 47% of the US. Dollar Index.

Not surprisingly, we can a similar set up for the Dollar against the Euro.  The euro looks like it has imminent potential to rally against the dollar which means dollar weakness.


The Euro, opposite to the dollar is sporting a very nice downward sloping resistance trend line, while also experiencing a loss of downward price momentum.  Reflecting the dollar, the euro has approached a significant support area that seems likely to hold, at least temporarily.  If/when the Euro is able to break this trend line, it will at the very least signal a short term change in trend to alleviate the oversold condition.


High aircraft utilization translates to robust on-line shipping

Many economists have expressed concern over the low peak season shipping levels, especially coming into the holiday season.  We commented on this observation last week and confirmed the downtrend in port activity with our Dry Cargo Index.  However many speculated this import slump might not reflect a poor holiday buying season – instead it might be due to retailers having higher inventory on hand than previous years.  

There is no doubt consumers are feeling the pressure as wages remain stagnant despite increasingly low unemployment.  This pressure however is being offset by record low gas prices and an increasingly strong US Dollar, so how are consumers going to spend their money this holiday season?  The Cass Freight Index for October shows a year-over-year change of -5.3% for shipments with the past several months remaining steadily below 2013 levels.  How these data translates to consumer spending this holiday season remains unclear.  However, shipping companies such as UPS are still predicting an increase in shipping this season.  Retailers seem to be equally uncertain as to how the holiday season will affect them.  Third quarter earnings were mixed for retailers, with good news from brands such as Home Depot and Amazon, while others like Target continue to struggle.  One distinguishing shift in spending is the increasing volume of on-line retailing.  Despite the pressure on retailers to deliver better deals this Black Friday, many consumers are spending their time shopping on-line instead of waiting in long queues this Friday.  comScore reported its official forecast for the November/December holiday season and predicts on-line spending will reach $70.1B, a 14% gain from last year.

FedEx Utillization
Average aircraft utilization for FedEx

This increase in on-line spending and mixed brick-and-mortar performance might be confirmed by the higher volumes expected by shipping companies such as UPS and FedEx. The FedEx Cargo Utilization Index trends the cargo aircraft utilization in real time and can give us some insight on the cargo levels for FedEx, which transports many on-line purchases. The data above shows overall aircraft utilization has been trending upwards since mid-summer, indicating an increase in overall air freight volume for FedEx.  Additionally, we can see aircraft utilization by type, which shows a similar trend (below).  Interestingly, much of the increase in utilization can be seen specifically in 777 and MD-11 utilization.  Typically these aircraft are used on longer international routes, meaning the increase in their utilization might mean retailers stocking up last minute before the holiday rush.  More information on the FedEx Cargo Utilization Index can be found under our Indexes menu.

FedEx Utilization by type
Aircraft utilization by aircraft type

Even though the data points to muted holiday spending, there are a number of indicators that are showing growth in on-line shopping.  This correlates with the data we see from FedEx and their increased aircraft utilization coming into this holiday season.

Global dry cargo slump? Perhaps also beyond the U.S.

The Wall Street Journal recently published an article detailing the slowdown of U.S. port activity for the months of September and October.  These data indicate that during an otherwise typically busy time of the year, imports have declined at each of the three busiest seaports in the U.S.  Economists are insinuating this might indicate a larger global problem and is not limited to buildup in inventory but instead a more systemic global slowdown.  News from China and now from Japan correlate with this sentiment.  However, the U.S. market continues to show strength with consumer spending on the rise and an all time high in equities thanks to continued low interest rates.  

Total shipping volume in TEUs


Cargo vessel utilization 

Data from our own Dry Cargo Index corroborates this assessment.  For both of these months dry cargo levels on averaged showed a decline.  Additionally, the number of vessels showing they are actively underway have decreased as well indicating lower utilization overall.  However, for the first half of November dry cargo levels have leveled off and are trending slightly upwards.  These data are interesting since the GFC Dry Cargo Index monitors cargo shipping levels globally instead of concentrating on only U.S. shipping activity.  Furthermore, our index concentrates on the largest of the cargo shipping vessels indicating on a global scale dry cargo shipping globally is also seeing a pullback.  Although a slight decline can still be inferred for September and October, the WSJ article references imports in the U.S. are up %4 for the first 10 months this year compared to last.  It is still unclear if this trend will continue past the peak shipping season, however the GFC Cargo Index seems to correlate with the slowdown in U.S. imports.