During this period of price deflation and excess capacity of almost everything except fair treatment of the taxpayer out of Washington, the yield on long Treasuries has skyrocketed. This is now discounting inflation in the out years well above the (say) 3% rate that has existed on average since the formation of the Fed and institutionalization of inflation rather than price stability in this country. If Treasuries are not a buy, then nothing much else is except gold.
Spot gold itself is up 30% since its low of half a year ago at $720/oz. It has also potentially failed against the double top of last July and this February. This may be a bullish portent for Treasuries. The inflation-deflation adjusted (i.e. real) yield on Treasuries is as high as almost any yield that existed during tightening periods in the Volcker/Greenspan eras.
What may be happening in Treasuries and in the economy happened in the Great Depression. Let me refer you to Paul Lamont, a financial historian who has made some marvelous calls this cycle. On Jan. 5 of this year he published on the Web "The Haughty Bond", which pointed out:
The investment herd is currently engaged in a Bond buying frenzy. They believe that inflation will be low for an extended period. We agree. While we may have inflationary countertrend rises, overall we are in a deflationary environment where banks fail, assets fall and the economy deleverages. However as history shows, government bonds were sold in the deflationary spiral of 1930-32. The excuses were two fold: liquidity concerns and inflation fears. Banks sold bonds (their mortgages were frozen) to raise cash reserves in case depositors decided to withdraw funds. In addition, major government interventions at the time (sound familiar?) caused a fear of long term inflation. The dumping of Treasury Bonds finally stopped in June of 1932 (the same month as the stock market bottomed). So Bonds depreciated in the historic deflation of the early 1930’s, but is this relevant today?
The current bull market in Bonds has lasted since 1980. But only recently has the Treasury Bond market registered a record extreme in bullish consensus according to MBH Commodities' Daily Sentiment Index. Now for the first time in 28 years, 99% of traders believe the upward trend will continue. Remember when everyone thought real estate could only go up in value? At this point, the Treasury Bond market is swaggering around, certain of its own opinion that it cannot fall.
In this scenario, mortgage-backeds should be sold aggressively, as they have been far to strong vs. Treasuries, or held to term. Now that there has been an historic steepening of the Treasury yield curve with an equally historic percentage increase in yields of 85% (from 2 to 3.7%) in about 5 months in the 10 year T-bond, Lamont's analysis suggests that one can now buy intermediate to long-term Treasuries either to hold for the long term or to trade out of on price strength. This was the right strategy during the Great Depression until WW II inflation hit and remains a potentially potent risk-reward strategy for an appropriate portion of a portfolio today.
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