Monday, August 30, 2010

The Treasury "Bubble"

A huge majority of investment "experts" and pundits watching the action unfold in the treasury markets have been treating the recent upswing in prices as its own little corner in the big picture.  Investors and advisors alike regard treasuries as relatively insulated from the rest of the markets, or at best correlated in an inverse manner.

However, when I look at treasury bonds, all I see is a tiny piece of a much larger puzzle.  Seeing the forest for the trees, as it were.  That forest is the debt saga that has grown and bloated and expanded for over 70 years, resulting in the largest financial bubble ever to grace mankind's irrational nature.

The treasury market is more like a stop in the game of hot-potato.  Investors, fund managers, pension funds, et al, are trying to find a safe place to park their cash and make some money from it.  From securitized consumer debt to corporate bonds to munis to regionals to treasuries.  The hot potato gets passed along.

Municipal bonds are a disaster waiting to happen.  This has been well-documented by some very astute observers and I won't touch on it now.  Everyone and their uncle already knows the story with securitized consumer debt - that's been old news since 2007.  State bonds are starting to become highly questionable - some states, like California, have a higher probability of default than Portugal.  Foreign sovereign debt prices have been dropping consistently as sentiment towards debt once again resumes it pessimistic shift.

The last domino to fall, then, is Treasury Bonds.

Long-lauded as a safe haven, due to the state's ability to use its monopoly on violence to gain funds and its political ties to the printing press, Treasury bonds have had quite the run of late.  Virtually no one is bearish on this final domino in the debt bubble (98% bulls registered on the DSI last week).  While we could see a pop in bond prices, this move is exhausted and near its end.

I have written before about how a deflationary environment can still drive up yields as the probability of debt repayment drops drastically with the contstriction in available free cash.  This should be the reality of the situation over the coming years.

The moral of this story is:  Treasuries aren't in a bubble - debt is in a bubble.  Treasuries are just another name for the same thing - someone taking on an obligation they cannot repay.  We are unwinding several generations of positive sentiment that morphed into a mania - this is not a slow and easy process. 

And a classic pattern to end the move in a classic "safe haven":

As you can see, this is not a pretty picture for long term Treasury holders.  The coming move is going to take millions of investors, pension funds, traders, etc. by surprise. 

As such, my recommendation is this:  Short Treasury Bonds - the longer term the bonds you can short, the better the results will be.

Have a great week!