It is high time for our political leaders to make some key decisions.  And that translates into large uncertainties for investors that have held the market in a range and with low volume. We do not know whether “Cap and Trade” legislation will pass the Senate and we do not know whether and any healthcare bill will pass through Congress, or what that bill might entail.  And these two issues are paramount for the future of America.  

As we discussed earlier, cap and trade could cause incremental costs in energy for all of the United States, particularly in all carbon-based generation of electricity.  Increasing these costs will make carbon-based energy less competitive with alternative sources, like solar and nuclear.  The benefits of this legislation will be less carbon emissions, cleaner air, less dependence on imported oil and the creation of new jobs in the alternative energy sector.

However, this all comes at the expense of jobs in the traditional energy sector, which is currently the backbone of our energy policy. It also means higher job losses in the rest of the economy due to higher energy costs.  Remember that the United States is the “Saudi Arabia of coal,” given its abundance here.

All of these uncertainties are huge, as are the stakes for a multitude of sectors.  I have been surprised by the unpredictable decisions of our legislators many times.  In addition, legislative add-ons that tack hundreds of pages onto a bill right before it comes to a vote make prior analysis nearly impossible.  Therefore, unless the outcome is almost a foregone conclusion and the details are clearly spelled out well beforehand, making strong bets on their legislative outcomes is just plain gambling.

The unemployment rate rose to 9.5% in June as the economy shed 467,00 jobs. That’s up from 322,000 in May.  Jobs are a lagging indicator and tend to peak well after the economy has peaked.  But they are the best coincident indicator of economic activity.

Warren Buffet recently said that he has not yet seen any green shoots in the economy.  Conversely, General Electric Co. (NYSE: GE) Chief Executive Officer Jeffery Immelt said that all the pieces are in place for a recovery in the United States.  Yet the only areas of strength he mentioned were abroad:  China, some areas of the Middle East and other emerging economies.

But what we can all agree on right now is that there is no inflation in sight, despite the massive amounts of quantitative easing from the U.S. Federal Reserve.  But it won’t be long before inflation does rear its ugly head.

Like the people in Germany who were deeply affected by hyperinflation, I remember living and analyzing companies in Argentina in the 80s with inflation rising at a rate of 1% a day.  It was not fun, and the distortions to economic activity and financial statements were amazing.

Although the Fed has repeatedly indicated that it is ready to remove the monetary stimuli at the appropriate moment in an aggressive-enough fashion so as to preclude an inflationary spike, neither we can be sure that the central bank’s actions will meet with immediate success.

Federal Reserve Chairman Ben S. Bernanke is very capable and his resolve gives me comfort, but as former Fed Chairman Alan Greenspan told us when he was running the central bank, there are important variables in monetary policy that the Fed cannot know for sure: Among them are the lags between the Fed’s actions and the response in the economy and the precise sensitivity of the economy’s response to the Fed’s actions.  It is like steering a large transatlantic ship while watching in the rearview mirror.  By the time you see an iceberg, the ability to reverse or alter the course is very limited.

If we observe that the level of both monetary and fiscal intervention in the economy is at historic highs, then we have to understand that applying the just doses of intervention and reducing those doses as the economy gains a “self-sustaining” pace is a very tricky exercise.  Even allowing for the best of intentions and the immaculate professional abilities of the Fed, this will be a very difficult task to pull off.  And what is self-sustaining growth, anyhow?

We also need to understand that the current reflationary policy, which was employed to prevent the country from falling into a deflationary spiral, is actually seeking to create a little inflation.  And it would be unpardonable to see the country fall back into a double-dip recession after all this intervention, should the Fed pull on the reins too soon.

In fact, the Fed and the Treasury Secretary Timothy F. Geithner have repeatedly led us to believe that they intend to see the recovery ingrained before withdrawing significant amounts of stimuli.  It makes all the sense in the world.  The logical implication is that they would rather see an unpleasant reading or two on the inflation front than see an unpleasant reading on the growth side.  It is a very difficult situation to manage and they are not perfect.

So right now, when inflation expectations are well subdued, it is a good idea to add a position in Treasury Inflation-Protected Securities (TIPS).  The easy way of doing this is by buying the iShares Barclays TIPS Bond Fund (NYSE: TIP).

All of these pending uncertainties that I mentioned are adding to the traditional summer doldrums and we are seeing very low stock trading volumes.  So we are going to take advantage of the situation to get a good valuation on these bonds well before inflation expectations pick up.

Also, adding bonds to the portfolio has a stabilizing effect.  And the two traditional worries with bonds: A drop in the value of the U.S. Dollar and an increase in inflation are actually hedged, at least in part, with TIPS.  Because inflation is fully hedged as the principal is indexed by the consumer price index (CPI) index.

Recommendation: iShares Barclays TIPS Bond Fund (NYSE: TIP)at market (**).
(**) - Special Note of Disclosure: Horacio Marquez holds no interest in the iShares Barclays TIPS Bond Fund. ]]> http://www.contrarianprofits.com/articles/the-ishares-barclays-tips-bond-fund-is-a-good-way-to-brace-for-imminent-inflation/18728/feed 0 http://www.contrarianprofits.com/articles/two-ways-to-protect-yourself-when-the-inflation-alarms-return/14930 http://www.contrarianprofits.com/articles/two-ways-to-protect-yourself-when-the-inflation-alarms-return/14930#comments Fri, 13 Mar 2009 15:31:11 +0000 Mike Caggeso http://www.contrarianprofits.com/?p=14930 Like a vanquished enemy, inflation has been out of sight and out of mind. But old enemies can resurrect themselves.  And that’s just what’s going to happen with inflation, two fixed-income experts say.

In a report posted on the Web site of Pacific Investment Management Co. (PIMCO) – which runs the world’s biggest bond fund – Chris Caltagirone and Bob Greer said inflation will return as soon as 2010 and will remain a factor for some time to come after that- a scenario that makes commodities and TIPS (Treasury Inflation-Protected Securities) “two [investment choices] that can provide investors diversification as well as exposure to sectors that may benefit from future economic developments.”

In the near term, however, Caltagirone and Greer expect excess…

This from Eric:

The flaming embers of inflation have already landed atop the thatched roof of American finance. And yet, investors can still buy inflation insurance on the cheap. In the next 1,373 words, we’ll examine a few of these “insurance policies”to assess their virtues and drawbacks.

Since a powerful new inflationary trend is very likely to occur, the prudent investor should probably take steps to guard against it. “But wait a second!” some readers be saying. “What if a powerful deflationary trend occurs first?”

Good question. It might. But we’d begin preparing for inflation anyway. Why not prepare for the near-certain arrival of inflation, rather than the uncertain timing of it.

If an infallible clairvoyant told you that your house would burn down in one of the next five years, would you say to yourself, “Gosh, maybe I should try to figure out which year it will be and not buy fire insurance during the other four years.”

You might actually guess correctly, in which case you would have saved yourself four years worth of insurance premiums. But you might guess incorrectly, in which case you would have lost your house.

Your call.

To this market observer, inflation seems like a near-certainty. Not an absolute certainty, mind, you, just a near-certainty, sometime within the next three years. So why not beat the rush to buy inflation insurance? Why not buy some now?

The nearby chart displays a sampling of inflation hedges, and how they performed during the last eight years of the infamous 1970s. Gold was clearly the standout winner. But we’d put an asterisk next to this result, due to a performance-enhancing assist from the U.S. government. During most of the preceding four decades, the US government had been artificially suppressing the gold price, while also forbidding private citizens from owning it. Therefore, once the government stopped its meddling, the gold price partied like a teenager whose parents had just left town.

Aside from gold, very few assets managed to keep pace with inflation, as measured by the Consumer Price Index (CPI). Hard assets like the CRB index of commodity prices and the Swiss franc did outpace the CPI, but stocks and bonds both lagged miserably.

Skipping ahead about 30 years, we can see that the modern versions of the 1970s inflation hedges have performed quite poorly during the last 14 months. Clearly, inflation is not a widespread concern. But that’s part of the reason it concerns us, and also part of the reason why we’d be inclined to take action now, while inflation hedges remain relatively cheap.

Our contrarian instincts lead us –rightly or wrongly – to distrust the consensus, especially when the consensus trusts in an idea as stupid as deflation…just kidding. We don’t think deflation is stupid, just unlikely. (More precisely, we suspect that deflationary indicia will be seasonal, like daffodils. For a while, they will seem to be everywhere. Then, just as suddenly, you won’t be able to find a single one).

So with that biased and unscientific preface, let’s sweep through a Reader’s Digest review of ETFs that might provide some kind of hedge against inflation:

1. Gold – The “Old Faithful” of hedges. It’s always worked before. Enough said. ETFs like the SPDR Gold Trust (GLD) provide easy access. With a $30 billion market capitalization, this is the “go-to”gold ETF. The next largest entrant is the iShares Comex Gold Trust (IAU) with a market cap of $2 billion. Both ETFs enable an investor to buy gold with a mouse-click. No muss. No fuss. But purists may wish to buy bullion coins like Krugerrands or Maple Leafs. As a gold investment, bullion coins have the advantage of being shiny, pretty and portable. But they have the disadvantage of costing 6% to 10% more than bullion itself, while also being so shiny and pretty that someone might want to steal them.
2. Gold Stocks – The bastard brood of gold and the stock market. As inflation hedges, gold stocks can be somewhat unpredictable and capricious. Over a multi-year span of time, they tend to reflect that gold side of their heredity. But during shorter time spans, gold stocks can behave much more like stocks than like gold…and that’s not always a good thing. That said, ETFs like the Market Vectors Gold Miners (GDX) provides a handy way to buy a basket of gold stocks.
3. Commodities –Like gold, a basket of commodities that includes crude oil, copper, wheat, gold etc. tends to provide a very reliable hedge against inflation. Unlike gold, a basket of commodities provides diversification across multiple assets and therefore, much lower volatility than gold. The largest commodity ETFs available are the PowerShares DB Commodity Index Tracking Fund (DBC) and the iShares S&P GSCI Commodity-Indexed Trust (GSG). DBC holds only six commodities: Crude oil, heating oil, aluminum, corn, wheat and gold. GSC holds a much broader collection of commodities.
4. Commodity-focused stocks. See comments on #2 above. The iShares S&P North American Natural Resources Sector Index Fund (IGE) provides broad exposure to commodity-focused stocks. Alternatively, the DWS Global Commodities Stock Fund (GCS) is a small closed-end fund that holds a similar portfolio. But GCS is selling 12% below its net asset value, which means that a buyer at the current quote controls one dollar worth of resource stocks for only 88 cents.
5. Non-Dollar Bonds – The Swiss Franc performed quite admirably during the last Great Inflation in the United States. But we are hesitant to bet on a repeat performance. Indeed we are hesitant to bet on ANY foreign currency as a way to hedge against US inflation. The Swiss economy, for example, no longer features a bunch of pocket-watch-toting gnomes guarding vaults full of gold bullion. Instead, the modern Swiss economy features pocket-watch-toting gnomes masquerading as hedge fund managers. The predictable result is that Switzerland’s two largest banks have amassed questionable derivatives exposures that exceed the GDP of the entire country. Many other bankers speaking many other languages have achieved equally enormous feats of stupidity. No one knows how these feats of stupidity will influence the values of their native currencies. Not knowing, therefore, we are disinclined to guess. But those readers who suspect that the dollar will be one of the first currencies to go down in flames, rather than one of the last, might be interested in the one of the many ETFs that hold foreign currencies. The CurrencyShares Swiss Franc Trust (FXF), for example, holds Swiss francs. Alternatively, the dollar-phobic investor could purchase the SPDR Barclays Capital International Treasury Bond ETF (BWX) that holds a basket of bonds issued by foreign governments. Its largest allocations include a 23% weighting in Japanese government bonds, 12% in Germany and 12% in Italy.
6. TIPS –No discussion of inflation hedges would be complete without mentioning TIPS, short for Treasury Inflation-Protected Securities. [To learn more about how they work, check out the November 26, 2008 edition of the Rude Awakening]. Investors may purchase a basket of TIPS by buying the iShares Barclays US Treasury Inflation Protected Securities Fund (TIP). In theory, TIPS provide a direct and reliable hedge against inflation. But like so many other seemingly brilliant ideas, TIPS work better in theory than in practice. The first risk is an overt one – deflation might persist for longer than expected (by us). In which case, the principal value of a TIP could decline below par. And even though the holder of the TIP would receive par at maturity, the interest payments that the holder would receive between now and maturity would decline in concert with the declining principal value. The second risk is a covert one: the federal government controls the calculation of the Consumer Price Index (CPI). Therefore, if the CPI, as currently constructed, were to get out of hand and produce very high inflation readings, the government’s bean counters would probably spring into action to create a “new and improved”CPI that would deliver much lower inflation readings. It has happened before.

Thus concludes our review of inflation hedges. We hope all readers will utilize the delightful deflationary interlude we are now enjoying to prepare for what may lie ahead. Hostile inflationary forces may be amassing their forces at the borders of our economy at this very moment. In short, we think it’s a good time to risk being paranoid about the threat of inflation.

Source: Inflation Gestation

This from Taipan Daily:

The euro is fast approaching an inflection point.

On Jan. 15th – Thursday of this week – the ECB (European Central Bank) will meet to decide how much to cut interest rates. The general consensus is that the cut will be big.

I wonder if the euro will “pull a sterling” and go up instead of down on the news. The chart certainly leaves room for that possibility.

As you can see, the euro’s move higher in December was sharp and swift. The ensuing downdraft has been more of a sideways lurch, creating something of a wedge formation. A sharp move back above $1.35 (and above the 50-day MA) could thus see some real upside follow-through.

While it’s generally true that anything can happen, it feels even more true in forex these days.

“Currencies Trading All Over The Map,” the Washington Post reports. “Over the past several months, global exchange rates have taken some of their wildest swings in years, with a fresh bout of zigzags hitting an array of currencies in both rich and poor countries in the past few weeks.”

Much of this uncertainty is tied to the prospects for U.S. recovery and the $64 trillion inflation versus deflation question. The theme song for the period could be “Should I Stay Or Should I Go” by The Clash: If I go there will be trouble… if I stay it will be double.The good news is currencies historically have a very strong tendency to trend. That means an “all over the map” currency period that began in 2008 could revert into a new stretch of powerful (and profitable) trending behavior in 2009.

And speaking of The Clash (and whether “to stay or go”), the powers that be threw a little more light on the subject of treasuries this week. In a speech to the London School of Economics on Tuesday, Ben Bernanke reminded his audience of the Fed’s willingness to buy long bonds.

“In determining whether to proceed with such purchases,” Bernanke said, “the committee will focus on their potential to improve conditions in private credit markets, such as mortgage markets.”

Brother, Can You Spare Some Inflation

What does that mean? It means the Fed wants inflation, ladies and gentlemen, and will do what it takes to get it.

A small helping of inflation would do nicely, but they’ll take a godzilla-sized helping too, if need be. Beggars can’t be choosers.

The logic is straightforward here. If deflation continues to grip markets, then credit conditions will clearly need “improving,” which, as Bernanke spelled out in London, would mean the Fed buying up treasuries with freshly printed dollars.

If, on the other hand, private credit markets start to “improve” on their own – without the Fed’s help – that means a flood of TARP cash, currently idle in bank vaults, is trickling its way back to work.

Either way, the end result is more dollars circulating through the system – and a jolt of reflation (maybe a BIG one) to go alongside.

Here’s a TIP

The “all roads lead to inflation scenario” is one reason Bill Gross is so high on TIPS, or Treasury Inflation Protected Securities.

Gross, the manager of the $128.4 billion PIMCO total return fund, managed to outperform 99% of his peers in 2008. He and a few others consider TIPS an amazing deal right now, in large part because the bond markets are still priced for heavy deflation. (TIPS outperform normal bonds in times of inflation, but underperform in periods of deflation.)

This presents another interesting way to think about the short treasuries trade – in the context of a TIP/TLT spread. (TIP is the iShares TIPS ETF; TLT is the 20+ Year Treasury ETF.)

As you can see from the chart, TIP dramatically underperformed relative to TLT all through the second half of 2008. This was due to the deflationary impact of the “great unwind” as credit flows collapsed.

You can also note from the chart that, as of late December, TIP started gaining ground again. Inflation-linked securities have grown more popular in recent weeks, as some look around and see the money-printing handwriting on the wall.

Source: Another Way to Play Inflation? Pssst, Here’s a Tip

U.S. Treasury bonds, the only asset in the world appreciating along with the dollar and the yen since mid-July, have skyrocketed in value since November 18. The yield on the benchmark 10-year Treasury now fetches just 2.54% – the lowest yield since 1954.

Even more incredible is the yield now offered by short-term government bills. It’s possible that yields might even turn negative before the day is through. The last time T-bill yields turned negative was in the 1930s; a negative interest rate implies investors are paying the government to park cash and not the other way around.

Evidence of heightened investor fears reached a nadir this morning with 30-day and 90-day U.S. Treasury bills yielding only 0.10%, or ten basis points – the lowest such yield since the 1930s. And six-month T-bills now yield a meager 0.20% – also in the record books.

The great paradox about the credit crisis at this stage is how investors continue to lunge after super low yielding T-bills and T-bonds when an entire gamut of fixed income markets – many with implicit government guarantees – are yielding north of 7%. Investors are indeed pricing in a serious deflation.

The U.S. 30-Year Treasury bond now yields just 3.04%, also trading at a 53-year low. Why would someone give the government money for 30 years at these rates? Short of a full-blown Depression, which I don’t think will occur, long-term bonds are the most overvalued asset in the world leading up to over $1 trillion dollars worth of Treasury bond issuance in 2009 and probably more in 2010. The only reason why an investor would buy this paper now is because of imminent financial Armageddon.

Meanwhile, investors are paid to take risk. And the values now in high quality investment grade corporate bonds, agency bonds, TIPs and convertible bonds are just too compelling to ignore. These markets all crashed starting in mid-September but have started to recover nicely over the last three weeks while stocks gyrate like a yo-yo. A 7% yield today seems mighty sweet.

Financial Armageddon is still a possibility. Global central banks and governments have spent trillions since August 2007 attacking clogged credit arteries, but only with limited success. At some point, however, I truly believe central banks will restart credit markets again as coordinated policy finally begins to work. Credit markets will unclog.

Tired of trying to pick a bottom in the stock market? I am. I have no idea where stocks are heading from one day to the next amid intense volatility. But I do believe high quality fixed-income securities should be purchased at these attractive levels for long-term investors. The values are too attractive to ignore.

Also, assuming stronger credits have stabilized at this point, investors can buy this sector without the dizzy volatility associated with common stocks, which ultimately lead to ulcers anyway as new lows are violated following every rally since last October.

Source: 30-Day and 90-Day T-Bill Yields Plunge to just 0.10%

We’re “officially” in a recession and the panicky markets are bracing for deflation. But what most investors don’t realize is that inflation – not deflation – is the real threat that they face.

For more than a year now, I’ve been telling readers and attendees at financial conferences around the world that the United States has been in a recession since last November.

I was wrong.

But only by a month: According to the National Bureau of Economic Research (NBER) announcement last Monday, we “officially” entered into a recession last December.

Now, I realize that stocks have taken a drubbing in the past few months. And the odds are good that share prices will get beaten down further in the weeks ahead. But that’s actually good news – and for three reasons:

• The NBER, which called the recession — apparently from its suite in the “Better Late Than Never” Department — is not known for being timely. In fact, its timing is so consistently bad that this latest recession pronouncement might actually be viewed as the light near the end of the tunnel. Indeed, of the four recessions since 1980, the NBER announced that we were in a recession in a (somewhat) timely fashion only once. That was in 1981, a full six months after the recession actually started.  But in each of the other three recessions – 1981-1982, 1991 and 2000 – the NBER didn’t officially label the deteriorating economic conditions a “recession” until the downturn was nearly over.

• In three of the past four recessions – 1980, 1991 and 2001 – the Standard & Poor’s 500 Index had already reached its recessionary lows at the time the announcements were made.

• Since 1900, the average length of a U.S. recession is 14.4 months. Assuming that historical relationships hold true, the NBER data, despite the fact that it’s a year late, falls in line with our suggestions of a few weeks ago that a late springtime rally may be in the works.

(Whether we believe that last point is another point entirely for reasons we’ve written extensively about in recent months. So we won’t rehash those today.)

But we will point out something that’s vitally important right now: There has not been a recession in history that wasn’t followed by inflationary pressure. And that, in turn, suggests that investors would be wise to shore up their defenses now while everybody is looking the other way … at deflation.

Why?

The U.S. Federal Reserve is expanding our monetary base by more than $11 billion a day since September to nearly $1.5 trillion, which represents an increase of 79.02% since October 2007.

What they are doing is unprecedented in recorded history.

On an annualized basis, the run rate in just the last few months alone works out to more than 369.92% per year – which means the monetary base is accelerating dramatically (See accompanying chart).

According to the Federal Reserve’s latest H.3 report, dated Nov. 28, bank non-borrowed reserves fell to -$362 billion, more than doubling the -$158 billion reported in September. Meanwhile, the preliminary Nov. 19 two-week figures reflect total borrowings are now $652 billion, up 11.85% over the same time period.

At the same time, total borrowings (TOTBORR) of depository institutions from the Federal Reserve have spiked dramatically, which signals still more money is working its way into the system. Note how smooth the TOTBORR chart has been historically for the last 22 years and how dramatically it’s spiked as a result of the financial crisis. When I say unprecedented, this is the kind of chart I’m referring to.

And we’re not done yet. In addition to all the infusions we’ve already mentioned, Club Fed is poised to inject another trillion dollars to bail out banks, insurance companies, Wall Street, possibly Detroit’s “Big Three” automakers and just about anybody else who “needs” a handout to overcome years of inept management,financial malfeasance – and plain old greed.

That’s why – more than any other single reason – deflationary pressures that might exist in the next six months or so aren’t really the enemy.

Carnegie Mellon University economist Allan H. Meltzer was much more in a recent interview with Forbes, stating that “people who say deflation is a threat are either rumormongers or ignorant.”

Added Meltzer:  “They need to take a refresher course in economics.”

As much as we’d like to dismiss Meltzer’s comments, we can’t. At least not entirely, because interest rate swaps are currently pricing in deflationary expectations.  And that speaks to something I’ve pointed out repeatedly: Any time the Fed squares off against the markets, the Fed loses. And it’s clearly fighting a losing battle now.

That’s why the bond markets are indicating deflationary expectations of 1.5% over the next two years and inflation of just over 0.0% over the next five years. Over the next 10- and 20-year periods, the markets are pricing in inflationary expectations below 2.0% respectively.

With an expanding monetary base already screaming inflation, this connotes opportunity.

The best way to capitalize on this in the long term is through Treasury Inflated Protected Securities, or TIPS. Right now they’re comparatively cheap because investors have fled to straight Treasuries, preferring their immediate liquidity. But TIPs are rising nicely and are likely to rise much further and faster with the first whiff of inflation.

Speaking of which, we think there is a 50-50 chance of so-called “core inflation,” which excludes food and energy prices, rising to 4.0%. That doesn’t sound all too bad, but that’s 2.3% more than the recent 1.71% yield on five-year U.S. Treasuries, which means TIPS are a better bet today.

Our favorite, the iShares Lehman TIP (TIP), sports an attractive 8.21% yield and plenty of upside. So it’s not only the good defense we’ve mentioned in the past, but one with plenty of inflation protection built in.

It’s up 14.35% from the low of $84.14 set Oct. 10. That’s something most investors are not focused on right now, but they should be.

Source: Inflation – not Deflation – is the Threat, Now Here’s What to do About it

This from Money Morning:

The U.S. Treasury Department announced Nov. 3 that it intended to borrow a record $550 billion in the fourth quarter. That represents a staggering $408 billion increase over Treasury’s borrowing estimate from early August and includes $260 billion for the recapitalization of U.S. banks.

Make no mistake about it: There will be enough U.S. Treasury bonds to choke on, as the government tries to finance this debt.

In the three months to Sept. 30, the Treasury Department borrowed $530 billion; in the first quarter of the New Year – which ends March 31 – it expects to borrow $368 billion. The March figure looks thoroughly optimistic; the monthly Treasury Statement of Receipts and Outlays shows that the first calendar quarter of the year is generally about $80 billion to $100 billion worse than the preceding fourth quarter. Thus a borrowing figure as low as $368 billion would seem to include no bailout costs and no additional recessionary costs from the current quarter.

If I had to guess, I’d assume borrowing would be about $500 billion in the first quarter, even if the U.S. banking system manages to say upright for the entire quarter – something that’s by no means certain.

Interestingly, Goldman Sachs Group Inc. (NYSE:GS) appears to agree with this. Goldman –formerly the country’s largest investment banker – said last week that in the year to September 2009 the Treasury would have to borrow about $2 trillion. That would suggest a rate of about $500 billion per quarter. That figure, too, is based on a belief that the recession remains fairly shallow, and that the new administration doesn’t have to add any major new stimulus programs – both pretty optimistic assumptions.

Goldman estimates that the Treasury Department will resurrect its three-year T-note issues, will speed up the issuance of two-year notes and 10-year bonds, and will “reopen” past Treasury issues that are now “off the run” (i.e. have maturities that aren’t a round number of years), thus adding to the supply of nine-year Treasuries, for example.

While the gross issuance of Treasury securities has to be netted against redemptions to calculate the net increase in Treasury borrowing, $2 trillion is a lot, and net of redemptions represents about $1.4 trillion in new money. That is unlikely to come from foreign central banks, the principal source of Treasury funding in the last few years. Net foreign purchases of U.S. securities in the 12 months to August 2008 totaled $543 billion, and it was about the same in the previous year. That means $800 billion to $900 billion of new money for Treasury purchases has to come from domestic sources.

Inevitably $800 billion to $900 billion of additional money flowing from domestic investors into Treasury bonds will do three things:

• It will drive up interest rates on Treasury bonds.
• It will tend to “crowd out” other financings, making finance difficult to obtain for medium-sized and smaller companies and more expensive even for the behemoths.
• And finally, it will increase inflation, as the Fed is forced to expand money supply to give investors enough money to buy all the Treasuries.

That suggests one overpowering conclusion: Don’t eat the food that Uncle Sam is trying to stuff you with in such vast quantities, except the short-term maturities if you are very hungry (have cash burning a hole in your bank account). If Treasury yields are going up, prices will drop, particularly at the long end of the maturity spectrum.  Furthermore, rising inflation makes fixed-interest-rate bonds a poor bet.

If you’re really dying to own paper issued by the U.S. government, you should look at Treasury Inflation Proofed Securities (TIPS) on which interest and principal are indexed to the U.S. Consumer Price Index (CPI). These were a lousy deal earlier in the year, but yields have since risen. Now, you can get a yield higher than 3%, plus inflation protection on 10-year or 30-year TIPS. Indeed, at the 10-year maturity, TIPS yield 3.04%, whereas regular Treasuries yield 3.90%, indicating that the market thinks inflation will average only 0.86% annually over the next decade.

If the market thinks that, it’s nuts. If inflation averages 7.3% over the next decade, as it did in the 1970s, a TIPS purchase will yield about 10.3% in nominal terms, about as good as you will find anywhere and far above conventional Treasury yields.

Thus, inflation-linked Treasuries are currently a much better bet than conventional Treasuries, and well worth taking a look at. You might also consider the Rydex Inverse Gov Long Bond Strategy Fund (RYJUX), which invests in a portfolio of short positions in Treasury bond futures and will therefore rise in value as T-bond prices decline.

The U.S. Treasury may want you to gorge on its offerings, but in this case a strict diet is the best policy.

Source: The Treasury Department is Choking on Debt, But You Don’t Have To

This from Today’s Financial News:

With the stock market in turmoil over the past month or so, it is no wonder bonds are getting so much attention. Bonds can be safe and profitable investments for the right people. But not everybody should be fleeing towards the debt market, especially now.

Treasury bonds, those ultra-safe entities that fuel the government’s wild spending, have gotten the most attention. Almost every day, I read a headline that says something about investors fleeing to the safety of treasuries.

You and I are not the kind of investors they are talking about.

It is true that tens of hundreds of billions of dollars have suddenly been transferred to the treasury market. But it is not money from folks like you and I. When you and I have a pile of cash, we can put it in the bank. With the FDIC insurance limit up to $250,000, we can find a safe haven for our money, even if it takes a few different accounts to do it.

But what if you are a pension fund or hedge fund sitting on several hundred billion dollars in cash? You can’t just bury it in the backyard. And you cannot risk that much money in some shaky bank’s vault. So you have to find some other means, like treasury bonds.

The only reason these bonds, with their miserly interest payments, are getting such attention is because the Treasury is the safest savings account available for the world’s big-time investors.

Follow the leader… right off a cliff

But with so much attention focused on treasury debt, everyday investors are wondering if they should follow the big money. I have been asked several times over the last week or so if I believe it is appropriate to turn to government-issued bonds. Several people have noted deeply discounted I Bonds, which are designed to protect against inflation.

My answer to them is simple. Two months ago was the time to buy bonds. Now is the worst possible time. Sure, a certain portion of your portfolio must always be invested in the debt market, but now is certainly not the time to overweight that allocation.

For example, let’s take a look at those I Bonds so many people are watching. Bonds issued before November 1 will receive a coupon rate of 0% and an inflation adjustment of 4.84%. In six months, that payment will rise to 4.92%. Those are great rates, but as always, there is a catch.

To lock in those rates, you must hold the bonds for at least a year, and to avoid all penalties for early selling, you must hold the bonds for at least five years of their 30-year maturity. Sell before the five-year period is up and you will lose three-month’s interest, taking your payout to just 3.7%.  Obviously, if you are looking for short-term income, your money can work harder for you.

There are very few folks, even pundits calling for a deep recession, that believe the stock market will be lower in five years than it is today. We may have some ups and downs over the next few months, but in five years, you can rest assured we will be right in the middle of the next bubble.

That 5% you could get from I Bonds (interest rates will only remain that high if inflation remains high) will be tiny in comparison to the gains your neighbors and colleagues will be making.

Now is not the time to invest in bonds. It is time to dive right back into the equities market. If you need a few investing ideas, check out these Blue Chips that are selling for penny-stock prices. They are the ones that will earn you the kind of money you deserve over the next five years.

Sometimes it is good to follow the “big money.” Right now, however, it would be a tremendous mistake.

Source: The true story behind the bond market