Another Bubble In the Making
Published on December 29, 2008
Published on December 29, 2008
In recent past, we have gone through a lot of bubbles; Dot.com, Property, Housing, Free money (aka Credit) led boom, Commodities and Shipping to name a few. The interesting thing is that when something goes up, we think that there is a perpetual fuel inside the rocket that will continue to lift it forever. And when it start to lick dust, we think of those “rockets” as poor pigeons waiting to be adopted, if ever. But what goes “abnormally up” has to come down to follow its natural path. Here is another bubble, if I may say so-
Few weeks back the FED established a new target range for the federal funds rate of 0 to 0.25% and also hinted on buying long-term treasuries. I think treasury bond prices have been pushed to similar bubble patterns as it was in commodities, or Tech. Well I am not going to put fancy charts to explain that but look at the attached two simple charts, one for Crude Oil and another one for the 30 year treasuries. Crude oil is generall more speculative, and Treasuries in a way should be rather less speculative due to their fixed and known payments but the exponential rise without correction raises concerns.
First some theoretical perspective-
30 Yr Bonds- Suppose you buy a 30-year Treasury bond at today’s market price — it yields 2.60%. That means for every $100 you invest, you get $2.60 each year in interest for 30 years. Such lowly yields represent the case of “Deflation” or call it fear of “Depression” that many are comparing the current crisis with. 2.6%! Not a wonderful returns, but at least it’s safe — isn’t it?
Who would sell such a miserable investment? The US government and why won’t they when there are plenty of buyers (currently). And who was/is buying it? The Foreign holders funding US consumption and now also the generally scared investing public that would like to safeguard the money (aka The Dollar) expecting to get back at least the same dollar amount (it’s different story that by that time, the dollar bill may not be of the same value)
Here are key points to note-
Albeit, the Yield may go even lower from they are today, but for the above key reasons, I am beginning to be bearish on long term US treasuries. And for my bearish positions to be fruitful, money just has to flow out of treasuries. I don’t really have to bother which asset class it goes to as long as it leaves treasuries.
Just like other bubbles, I don’t know “WHEN” will it burst and therefore I am keeping my plans to hold, if needed, for rather a relatively longer time frame. If anything happens before that, that’s a bonus. If you do decide to follow this philosophy, pls do you due diligence and also make a habit to hedge your positions, so you have a chance to preserve capital even if you are wrong.
There are lots of ways to short Treasury bonds. You can do it directly, by selling actual securities short. Or you can short shares of a convenient exchange traded fund — the iShares Barclays 20+ Year Treasury Bond Fund (TLT). Or you can short Treasury futures contracts — or sell calls (or buy puts) on Treasury futures contracts.
Those who are OPNewsletter subscriber, pls wait for my e-mail on the forum to know how I plan to play this.
Disclaimer– As of this writing, I don’t have either long/short positions in US treasuries yet. I may get into one any time and change my view depending upon market action. Pls do your due dilligence before investing and keep a risk management plan in case the trade goes against your plan.