High-Quality Bonds: The Best Weapon to Battle Deflation
Jul 21st, 2009 | By Contrarian Profits | Category: Top StoryThe Fed is flooding the system with as much funny money as it can. US monetary base has shot up by over 100% this year. It’s the largest increase in 50 years by a factor of 10. This build up of freshly printed dollars threatens a dangerous inflation… but not yet.
As Notes faithful will know, we pinned our colors to the inflation mast some time ago. It is a clear-and-present danger. Especially considering that the feds have no way of paying off their massive debts without triggering an inflationary episode.
But underground investor Tom Dyson says when it comes to the prices of goods and services now, deflation is the name of the game.
Timing is everything in the investment world, of course. And knowing that inflation is on its way is no good to anybody unless they have a reasonable chance of knowing when the tide will turn. And considering Notes is first and foremost about money-making ideas, we’ve decided to hang up our inflation boots for a while and pass on one of the best deflation plays we’ve seen all year.
“High-quality bonds are the secret to investing in a debt deflation,” says Tom in DailyWealth. “As the prices of everything around you collapse, the coupon payments you receive from your high-quality bonds appear to grow.”
- For example, imagine you own a $1,000 bond that pays $100 a year for the next 10 years. The bond matures in 10 years and redeems for $1,000.The general price level in your neighborhood falls a little bit each year. In 10 years, you find the price level has fallen 20%. Now, the money in your bond has 20% more purchasing power than it did when you bought it initially.
Said another way, the price deflation will wipe out trillions of dollars in value. The assets don’t go anywhere. We’ll still have the same amount of land, houses, farms, and machines as we had before. They’re just worth a lot less. Each dollar left over at the end – the surviving dollars – will gain in purchasing power.
The key is, in a debt deflation, many bonds will end up worthless… as the assets backing them lose value and the people and businesses servicing the interest on them run short of cash flow. You must only buy the quality issues that have no chance of defaulting. Investors will recognize the value of these bonds as safe havens and bid their prices up.
There are 1,232 “bond” securities trading on the major stock exchanges, including the NYSE, the Amex, and the Nasdaq. These include convertible bonds, preference shares, debentures, mortgage bonds, and secured bonds. These bonds trade just like stocks. You can get quotes throughout the day, you can buy and sell them through any discount broker, and you can hold them in your retirement account.
Many of these instruments are risky garbage issued by large financial institutions. But occasionally, you can find a diamond. Earlier this year, for example, I found an 11% bond backed by an $800 million pile of cash.
