June 3 Tweet on 10-year Treasury yield

Anybody else notice 10-year Treasury yields have climbed from 1.7 to 2.1%? Um, that's not supposed to happen with QE. Fed losing control?
— Gregory Nguyen (@dakyne) June 4, 2013

Central Banks Load Up on Equities

Speaking of bubbles...

http://www.bloomberg.com/news/2013-04-24/central-banks-load-up-on-equities-as-low-rates-kill-bond-yields.html

US Treasury bonds from a European perspective

Beijing needs the money at home in any case to prop up the Chinese economy – now in trouble. Even Japan has slipped into trade deficit.

Clearly, the US and European governments cannot rely on Asia to plug the $3.5 trillion hole in their budgets this year.

Asians are just as likely to be net sellers of their bonds. Which implies that central banks may have to "monetize" our deficits.

James Montier, from Société Générale, has examined US bonds back to 1798. Yields have never been this low before, except under war controls in the 1940s when the price was set by dictate.

That episode is not a happy precedent. The Fed drove the 10-year bond down to 2.25%, much as it is doing today with mortgage bonds. It helped America win World War Two, but ended in tears for bond holders in 1946 when inflation jumped to 18%.

Mr Montier said yields have averaged 4.5% over two centuries, with a real return of around 2%. By that benchmark, the market is now banking on a decade of deflation.

Investors have drawn a false parallel with Japan's Lost Decade, when bond yields kept falling, forgetting that Tokyo waited seven years before resorting to the printing press. Mr Bernanke has no such inhibitions. He has hit the nuclear button in advance.

"Today's yields are woefully short of the estimated fair value under normal conditions. There maybe a (short-term) speculative case for buying bonds. However, I am an investor, not a speculator," he said.

by Ambrose Evans-Pritchard

Bear Market Rally

Be careful--the equities market tanked 50%, already discounting all the bad news. It could test its lows again in the first quarter, but my long positions are doing quite well. Don't get caught up in the gloom and doom that's being reported. You should have been gloomy and doomy last year--before asset values plummeted thru the floor.

Again, employment and economic stats are retroactive--markets are forward-thinking. For instance, the government declared we were in a recession a year after the fact, when the markets clearly indicated we were already deep into one the year before. As usual, investing on what the government SAYS leads to disaster; it is more fruitful to invest on what the government DOES. And right now, they are printing our way towards inflation, due fears of deflation. The outrage is the pending inflation, dampening our savings and raising our cost of living (and killing our standard of living). Inflation is a "quiet" tax that the public ignores because it is slow and insiduous. But the Fed knows it can generally get away with it, especially if it creates jobs. So they drive us further into debt, when monetized debt was what goes us into trouble in the first place.

That's why oil and other commodities are soaring off their lows. And that's why T bond yields are bouncing off their bottom. As I mentioned last week, I shorted T bonds (I'm betting on interest rates rising), and it's paid off already. I've found a timing indicator which has proven uncanny, but my fundamental and subjective analysis has to be intact first. I won't just trade off of my technical charts, but I will use them to confirm my entry point into a trade.

Wall St. has an ongoing debate between the technicals (guys who strictly rely on reading price, volume and momentum charts) and guys who only do fundamental analysis (value guys like Buffett). I say do both. If my fundamental analysis tells me to either go long or short, I will read the charts before l pull the trigger. In general, the fundamental guys do better long-term, even if they mistime their entries. Buffett pulled the trigger too early, and hence is down 30% since his recent buys, but he can afford to wait it out 10 years.

Day traders try for incremental gains, which I find hard to achieve, because you have to repeat it many times. I swing trade, looking for reversals and big moves. I can be early too, but I am exercising more discipline and patience, waiting for my targets to hit their price points, and once they reverse their trend, I pile in. No one can capture the exact inflection points, but if you are close enough, you'll be able to catch the majority of the next big move up or down.

For instance, short term T bills are yielding 0%. I consider that situation unsustainable long-term. I don't know when or how hard rates will go up, but they will at some point. I'm not shorting them because the Fed can 100% influence short-term rates by setting the Fed funds rate.

The long end of the curve (30-year T Bonds) is a different animal. They also touched all-time highs, yielding an all-time low 2.5% recently. The Fed cannot control these rates--they are market-driven, and thus depend on market participants' forecast on inflation. When inflation goes up, long-term rates go up. Right now, the bet is that deflation will be upon us for the next dozen years, similar to the Great Depression. I say hogwash--because the Fed and Treasury are making sure that doesn't happen as they liquefy the markets with credit and tons of capital.

Once investors (mostly foreign) figure out tying up their money for 30 years at 2.5% is a poor investment, they will pour out of them en masse. Right now, everything else around them has collapsed, so they are fleeing INTO US Treasuries, but once they figure out other assets have a better chance of appreciating, they will vote with their dollars OUT of T Bonds, and into equities, commodities, and precious metals.

The bond (fixed-income) market is twice the size of equities, and dwarfs the commodities market. So any small change in asset allocation into equities and commodities has a levered effect on the latter--that's why you see such violent volatility in stocks and commodities (more so in commodities). Oil is up 30% from its lows already, while the prevailing public opinion is that filling up their tanks is still really cheap compared to last year. You ask the average person off the streets about the price of oil, and they'll tell you they're happy that gas prices are low. However, as a trader, if you were short oil, you would have been killed, due to the recent price spike and leverage.

That's why I ask people all the time what their opinions are on certain financial assets. I'll inevitably go against them. They are understandably bearish on stocks after the 50% haircut, while equities have started their bear market rally (the rally is unsustainable due to rotten earnings). As you know, and it's been documented, gold mining shares are up 100%, even as people consider golf a barbaric relic. I'm considering pulling some off the table to lock in profits, and have already purchased long-term call options to capture the next big move up later this year, in case gold stalls and consolidates, before resuming its incline.

But Treasuries are a screaming sell right now, assuming we don't go into Great Depression mode, resplendent with 25% unemployment. It could happen, but the probabilities are getting smaller with each printed dollar. Until then, the big move up is interest rates, commodities, and even some stocks (high cash, cash flow, market share monopoly, no debt, and a dividend if possible)...and the big move down is T-Bonds. Precious metals should resume their increase, but like I said, I've captured the big move, so I expect a pause.

So I've got the direction on certain assets down, but I am refining my market timing. These are understandably proprietary, because if everyone catches wind of it, it will arbitraged out, and I will have no longer have a competitive advantage. That's another reason why you want to be careful about bubbleheads on TV--they're not all idiots. If it's an economist or some "pundit", they probably really are stupid--or more accurately, smart, but wrong-way Corrigans. But if the guy has a stellar track record (ie he's a billionaire trader), and keeps a low profile, he may throw people off his tracks by design.

For instance, he may tell people he's selling wheat, hoping the wheat futures tank, all the while buying up the physical inventory at a lower price. That's one more reason why following CNBC of Fox business news is not only useless, it is potentially disastrous. Unless, of course, you use it as a confirming contrarian indicator.

Greg

Why "quantitative easing" will work, but at what cost?

The tandem of the Federal Reserve and the Treasury have taken extraordinary measures to solve the credit crisis. They've lowered interest rates as low as they can go (Treasury bills temporarily dipped below 0% yield recently), providing the markets with plenty of credit. The problem was no lenders were lending, and no borrowers were borrowing. Lenders used the swaps to shore up their balance sheets, dumping bad assets for Treasuries, but they weren't lending.

The Treasury stepped up by pumping the system with trillions of dollars, injecting capital in hopes of stimulating spending. It worked, so we can expect them to step up their efforts. It's one thing to extend credit; now the government is literally printing money out of thin air.

This is, by definition, inflationary. It's necessary to avert a category 5 Great Depression, but it will prove to be problematic down the road when hyperinflation rears its ugly head. Printing money also debases the local currency, as the US Dollar continues to plummet. This flight to quality and perceived safety (short-term T-Bills and long-term T-Bonds) is bumping interest rates down to historical lows, due to the high demand for Treasuries. The operative word is "perceived" as I will soon explain.

My investment thesis is that this low-interest environment will eventually reverse course, as investors demand higher rates of return once they realize how flimsy the US Dollar is. Parking money in Treasuries at such low rates will prove to be disastrous, as inflation asserts itself, accompanied by higher interest rates. Finance 101: when interest rates rise, bond prices decrease.

With borrowing costs so low, we are to the point where any asset other than cash seems too irresistible to pass up. Having said that, with fears of deflation and blood in the streets, temporary irrational pessimism could cause markets to undershoot more than they have. Therefore, despite snapback rallies, further lows could be tested in equities and real estate in this secular bear market.

It is impossible to time market bottoms or tops, but there is value for the patient. My contention is that inflationary monetary policy will eventually lead to inflation, and that precious metals will resume their secular bull market. Equities and other commodities will follow suit within the new couple years, and real estate will recover within 3 - 5 years. I am unsure of the timing, but the direction will reverse course eventually. In other words, I can't call the bottom, but we are closer to the bottom than a top, as many have already taken a 50% haircut on their portfolios and 30% on their home values.

Hence, my current positions are long gold, long the Japanese yen (short the US Dollar), short Treasury Bonds (10 - 30-year maturities). With inflation and rising interest rates, bond prices will plummet going forward.

For those favoring income and dividends, I believe high-quality corporate bonds are extremely attractive relative to Treasuries. A handful of shares are attractive, including companies with leading market share, high cash reserves, strong cash flow, and no debt. For the non-faint of heart, some high-yielding (junk) bonds may also be profitable due to their extreme spreads (20 points above Treasury yields). But be prepared for high default rates.

Please consult your investment and tax professional before investing.