Wednesday, January 7, 2009

Treasury Bonds tanking

Today was a watershed event in my eyes. Despite the feel-good moment the media and powers-that-be are trying to portray with today's presidential lunch, the markets reacted very unfavorably to Paulson's semi-admission that we are not out of the woods yet. For those that follow fixed-income markets (which is much bigger than the equities market, and hence, much more foretelling), the Treasuries bubble has burst, and the Fed and Treasury will no longer be able to influence the long end (30-year bonds). They have dropped short-term interest rates as low as they could, but the long-end is mostly market-driven. Buyers of bonds believe inflation will be muted going forward (either 10, 20, or 30 years). Sellers of bonds believe inflation will erode their returns. Mistakenly, bond buyers also believe they are safe havens. The future will prove this assumption false, as bond prices are subject to the soundness of the currency, inflation expectations, and supply/demand of said Treasuries.

Once the market figures out (and it eventually will) that the USDollar is about to be a toilet paper currency, they will demand higher rates of return, driving up interest rates--and basically undoing what the Fed and Treasury have worked so hard to do--lower long rates to reduce mortgage rates, and stabilize the housing market (hopefully). In other words, the gov't can only do so much--and artifically keep long rates down for only so long. The dam will eventually break, rates will soar, as will inflation eventually. The bottom line is that the Chinese and Japanese will no longer support the US deficit (our funding needs are in the trillions) and stop buying our Treasury bonds, as they retrench and try to stimulate their own economies. In other words, buyers at our huge debt financing auctions will be scarce. This is the final bubble bursting, and this time, no one will be able to step in to prop it up.

Anybody who lived thru the 70's knows how ravaging high interest rates are. To be honest, I've been shorting T bonds for a couple weeks, and with Barron's article over the weekend proclaiming the same, I actually have more conviction, as Barron's is one of the few prescient mediums. Gold is still in a secular bull market, but it is taking a necessary pause due to deflationary concerns. But even the Fed and Paulson are acknowledging the long-term risks of what they are doing--they just can't help themselves as they fear the mother of Depressions. Problem is, they are only delaying it, and exacerbating it with their monetary and quantitative easing (providing credit and injecting capital).

Despite periodic snapback rallies, we are in for a different era--and it's not going to be pretty. We are in for several years of deleveraging, with markets moving sideways with a downward bias. Gold and silver will continue their secular bull market.

I have incorporated a wave investment thesis, and firmly believe big asset moves occur approximately every 20 years. It's uncanny, and there is a reason for it: investing is generational. We have lost a whole generation of investors who will never touch stocks again, due to scandals, crises, TWO stock market bubbles, fraud, and most of all, LOST money and lost confidence that buy and hold works. They've seen their grandparents' retirement savings dissipate overnite, their parents lose their jobs, and their own job prospects bleaker than ever. THIS OCCURRED IN THE LATE60'S/EARLY 70'S, USHERING IN A DECADE OF DOLDRUMS! The former Nifty Fifty stocks collapsed, and I recall my dad's friends declaring they will never invest in stocks again. They were justified--until the 1982 bottom, when smart investors eased back into stocks, while the general public was shunning them. Previous false rallies were met with shunted resistance, causing the last bulls to throw in the towel.

A bottom was only formed because Volker said enough is enough, and raised interest rates into double digits (money market accounts were earning 12-13%!). Mortgage interest rates were 15%, because Volker shook out the excesses, and then ushered in lowered rates.

So given that this bear market began in 2000 with the tech bust, we've got another 8-10 years of crappy returns, with sawtooth volatility and sucker rallies. Warren Buffett himself warned of this 8 years ago, as he said investors needed to lower their expectations of equities going forward. Remember: between 1982-2000, stocks had their best run EVER! (Unfortunately, the average investor only earned 2.3% per annum during that span, as they are horrible market timers).

In fact, the only asset that gained in the 70's was our friend gold. I have no idea of the timing, but it is coming. Shorter-term, I'm already up 40% on my short T-bond trade (it's a double-short ETF) in a week. Despite further attempts to prop up bond prices, eventually the avalanche of sellers, and lack of buyers will usurp any attempts to prop up the US bond market.

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