Hedge fund legend Julian Robertson is betting the farm against long-dated US Treasurys. As Notes readers will be aware, we have been banging the drum on the vulnerability of long-dated US debt for over a month now. But Robertson, of Tiger Management fame, has a different way to make this short long-term Treasurys play (hat tip Market Folly).

Robertson is shorting long-dated US debt using something called a steepener swap play. Although the mechanism of this trade may be unfamiliar, at heart it’s a simple bet on inflation.

Robertson reckons inflation could easily hit 7% and that it could even reach 18%. Again, Notes readers will be familiar with this market script. This from eFinancialNews:

Steepeners are a type of interest rate swap, where one party agrees to pay the other a fixed rate in exchange for a floating rate, which is derived from the difference between long and short term rates. Many of these products also use high leverage, where the difference between the two rates is multiplied by up to 50 times to produce a higher return.

Retail investors can make the same play as Robertson without using interest rate swaps. It’s actually very straightforward.

Robertson is betting on the yield curve steepening. This happens when the difference between the yields of short-term and long-term US Treasurys increases. Robertson is essentially short the price of long-term US Treasurys and long the price of short-term US Treasurys.

Anyone with a brokerage account can do this by buying the iShares Barclays 1-3 Year Treas.Bd ETF (NYSE: SHY) and shorting the iShares Barclays 7-10 Year Treas.Bd ETF (NYSE: IEF). This would give you a leveraged return on an inflationary future, which not only Robertson but also many other underground investors we know are betting on.

Robertson reckons China and Japan will stop buying US government debt as the dollar weakens. This would bring down the price of 10-year T-notes and cause the yield to shoot up.

Of course, the reason Robertson is so sure that inflation is on the horizon is the Fed’s quantitative easing ‘solution’ to the economic crisis, aka the printing money route, combined with the enormous pressure on US Treasurys right now.

I’m amazed at the amount of money the government is throwing at this thing. You don’t even react anymore unless somebody’s talking about $1 trillion. I genuinely admire the administration’s courage in doing what it’s doing, but not the wisdom of it. I look at the TALF (Term Asset-Backed Securities Loan Facility) program, for example, and it’s almost a bribe to get people to put on more leverage … I ask anyone to give me an example of an economy beefed up by huge amounts of quantitative easing that did not inflate tremendously when or if the economy improved . I think what we’re doing now will either fail, or it will result in unbelievably high inflation – and tragically, maybe both. That would mean a depression and explosive inflation, which is frightening.

Even the mainstream media has started to pick up on the threat of inflation. How can you hedge against it other than by shorting long-dated government debt? Here’s what the Wall Street Journal recommends:

1. A managed gold fund such as Tocqueville Gold (TGLDX) or US Global Investors World Precious Minerals (UNWPX). This is a lower-risk alternative to buying gold directly, since the metal itself can be volatile.

2. A mutual fund that bets on long-term interest rates rising. The two best known are the ProFunds Rising Rates Opportunity fund (RRPIX) and the Rydex Inverse Government Long Bond Strategy fund (RYJUX).

3. An absolute return fund that can use derivatives and aims to beat inflation. An example: MFS Diversified Target Return (DVRAX), which aims to beat inflation over 5% a year over a market cycle. The problem: there are no guarantees. Many of these funds are new. And the track record is too short to judge.

4. Refinance your house into a new 30-year fixed mortgage immediately. Rates currently average about 5.32%. If inflation surges, rates will too.

5. Sell long-term bonds. A bond guaranteeing 7% a year for 30 years won’t be worth much if inflation hits 10% and CDs start paying 11%. Treasury bonds have sold off sharply. But corporate bonds haven’t. The yield gap between long-term investment grade corporates and 30-year Treasurys, which was nearly 5% in mid-January, has fallen to 3.5%.

6. If you want guarantees, buy inflation-protected Treasury bonds (TIPS). Right now, the 20-year TIPS yield is about 2.4% over inflation.

Commodity Trend Alert editor Eric Roseman is issuing a stark warning: Your bank could be next.

If you have money in the US banking system, he recommends you put it instead in Treasury bills or exchange traded funds (ETFs) that invest in short-term Treasury securities like SHV or SHY.

IndyMac Bancorp (NYSE:IMB) just became the latest mortgage casualty in the United States this month. More importantly, the headline-grabbing closure officially triggered the first attempted run on a US bank since the 1970s.

IndyMac’s collapse also marks the first time since the advent of the sub-prime mortgage crisis a year ago that a U.S. mortgage thrift has failed.

Last September, Britain’s Northern Rock (PINK:NHRKF) plc, a midsized mortgage lender, collapsed. Even though the Bank of England bailed the mortgage lender out, newspapers worldwide portrayed images of Northern Rock customers scrambling to access their funds for an entire month. It was eerily reminiscent of Depression era breadlines.

On July 14, IndyMac, the nation’s 10th largest mortgage lender, borrowed a page from Northern Rock as major financial newspapers depicted crowds waiting to access their funds.

IndyMac reopened its doors under federal supervision on Monday. They promised homeowners a lifeline from impending foreclosures. The FDIC also stepped in to protect funds up to US$100,000. However, US$1 billion dollars of IndyMac’s roughly US$19 billion in deposits was NOT insured affecting about 10,000 customers. But the FDIC has stated it would seek to return up to 50% of uninsured customer deposits.

If you’re holding the bulk of your savings at a U.S. bank — including the largest money-center banks, I strongly suggest moving those assets to TD Ameritrade. Use those funds to purchase Treasury bills or exchange traded funds that invest in short-term Treasury securities like SHV or SHY.

Also, other discount or full-service brokers will work, but just make sure to invest your funds in Treasury designated securities.

Also, consider mutual funds that offer “Treasury” or Government Securities” money-market funds. These products, offered by low-cost Vanguard Group among others, are safe, liquid and maintain a high degree of credibility since assets are 100% invested in short-term government paper.

The only cash sitting in a bank today should be to pay ongoing expenses, bills, etc. Don’t keep the bulk of your precious savings or liquidity stashed in a bank.

Until financial markets stabilize, head for the relative safety of government designated securities and products. These are uncertain times. Act now.

ERIC ROSEMAN, Investment Director

Source: Northern Rock Comes to America: Will Your Bank Be Next?