With the “not-as-bad-as-expected” news surrounding the economy and the initial government stimulus measures have been priced in to the market, we are moving into a period of profound uncertainty. With the release of Alcoa Inc.’s (NYSE: AA) earnings report, earnings season has officially begun.

In most cases each company’s own “easy” restructurings are also behind us.  They have resorted to massive lay-offs and inventory liquidations to bring costs down to the bare minimum required to run their respective businesses.  Those cuts and gained efficiencies also have been priced in.  Now, it is time for these companies to show what they can do organically.

Energy companies appear to have hit a wall now that China has run out of space to store oil. And other commodities businesses are suffering, too, as the U.S. Federal Reserve seems to have found religion and veered toward a much more prudent monetary policy.

After its last meeting the Federal Open Market Committee (FOMC) signaled the end of quantitative easing, at least for the foreseeable future.  This is of paramount importance, because it seems to be a concession to those who worried that the Fed might debase the U.S. dollar with by over-expanding its balance sheet and fanning inflationary forces down the road.

The Fed has done a tremendous job of first restoring some sense of “normalcy” and confidence in the core markets, like interbank lending and money markets, and then proceeding to work outwards to U.S. Treasuries and mortgage-backed securities.  This later step towards more prudent actions is welcome and you are seeing it in the U.S. dollar and renewed confidence in Treasuries.  The latter have been received extremely well by investors and yields have started to move down, reflecting not only the lack of current inflation, but also the confidence that the Fed will not go bananas with quantitative easing.

So, ahead of a very difficult earnings season, I am not going to try to out-predict the market.  The experts have been going around for a couple of months trying to just that by using expensive consultants that do channel-checking and by contacting the companies themselves to clarify statements made under full disclosure.

But the earnings season has extraordinary challenges to surmount, that are deriving from the uncertainty that is hanging over the markets like the proverbial sword of Damocles.

General Motors Corp. (OTC: GMGMQ) and Chrysler Group LLC are emerging from bankruptcy in record time and their costs, debt and massive corporate restructurings will probably make them internationally competitive once more.  But there are still questions about how these companies will cope with the still dormant auto market.

The outlook for the large financial behemoths that are due report earnings is equally uncertain. We still need to see how these institutions play around with their toxic asset valuations, their loan loss reserves and their predictions for the future, particularly given the potential stumbling blocks on the road to recovery.

The three obstacles that I find especially troubling are:

1. The spike in credit card delinquencies.
2. The outlook for commercial real estate.
3. And the pending second wave of residential foreclosures, now in the prime and option-ARM sectors.

But do not discount the possibility of seeing mark-ups in toxic asset valuations that might favor some financials strongly.

Now, with the Fed seemingly on hold and the U.S. government’s stimuli only 30% deployed and showing little traction, where is the growth going to come from, especially since unemployment blew right through the promised 8% peak to the current level of 9.5%? On top of that, last week’s rise in continuing jobless claims and Friday’s drop in consumer sentiment offered little solace.

The good news in all of this is that savings rates spiked to 7% as consumers used their money to pay down debt.  Even though this improvement in consumers’ balance sheets does not show in immediate sales growth, it bodes very well for the future.  And this savings trend, which translates into reduced demand for imported consumer products, together with rising exports, resulted in the lowest trade deficit in nearly a decade.

We are making the difficult progress that we need to make in order to restore the U.S. economy to financial health, and that, in turn, is helping the dollar and Treasuries in the short term.

So, based on these massive uncertainties, waiting to be played out, the best risk-reward ratio appears to be in bonds.  With a massive U.S. Treasury supply well absorbed, we are going to jump into long term U.S. Treasuries for a conservative upside, while we keep waiting for resolution on the healthcare reform, social security, and corporate earnings.

Recommendation: Buy the iShares Barclays 20+ Year Treasury Bond ETF (NYSE: TLT) (**).

(**) - Special Note of Disclosure: Horacio Marquez holds no interest in the iShares Barclays 20+ Year Treasury Bond ETF.

Source: Buy, Sell or Hold: Buy iShares Barclays 20+ Year Treasury Bond ETF For Solid Profit at a Time of Great Uncertainty ]]> http://www.contrarianprofits.com/articles/buy-sell-or-hold-buy-ishares-barclays-20-year-treasury-bond-etf-for-solid-profit-at-a-time-of-great-uncertainty/19017/feed 0 http://www.contrarianprofits.com/articles/the-bernanke-conundrum-guarantees-hyperinflation/17700 http://www.contrarianprofits.com/articles/the-bernanke-conundrum-guarantees-hyperinflation/17700#comments Tue, 09 Jun 2009 18:56:11 +0000 Andrew Gordon http://www.contrarianprofits.com/?p=17700 The moment of truth is approaching for the iShares Barclays 20+ Year Treasury Bond (TLT). As interest rates nudge upwards, the price of these long-term government bonds have been falling.

If Fed chief Bernanke can figure out a way to ratchet down interest rates, these bonds could begin to rise again. But he’s painted himself into a corner.

Bernanke could tell the Fed to extend its $1.75 trillion policy of buying government and mortgage bonds. That would lower rates in the short term.

But a policy of the government lending trillions to itself puts the government’s printing press into overdrive and practically guarantees hyperinflation in the future. That, of course, would make these bonds much less desirable and drive prices lower.

And if the…

In a speech before the student body, Lil’ Timmy told those gathered that Chinese dollar holdings and investments in U.S. debt were safe and that the U.S. Treasury and Federal Reserve are committed to a strong dollar policy.

Ha! That’s a good one. And the Chinese students let him know it, with a collective belly laugh. I suspect some of them were actually rolling on the floor. And they weren’t laughing with him. They knew he was full of it. I expect you do too.

Despite ongoing assurances to the contrary, the U.S. government doesn’t want a strong dollar policy. In fact, they WANT to inflate the dollar to nothingness. They just don’t want it to happen overnight.

The official U.S. debt is around $13 trillion. But that is only part of the story. Do you remember Enron and WorldCom and the fraud of “off-balance sheet accounting”? This is a dishonest accounting trick whereby companies set up satellite corporations to hide their true liabilities from auditors and investors.

The king of off-balance sheet accounting would have to be the U.S. government. You see, the “official debt” doesn’t include the very real obligations our country owes for Social Security and Medicare. Add these and a few other entitlement programs to the equation and the United States’ TOTAL debt is in the neighborhood of $100 trillion.

This is an astronomical sum of money that can NEVER be paid in real terms – even if most government services were virtually eliminated and taxes were doubled across the board. The only solution is to inflate the debt away by devaluing the dollar. The scoundrels in Washington are rarely honest about anything. You didn’t expect them to actually run a tight ship and pay our debts legitimately, did you?

The only problem is that the present financial crisis, bailouts and money printing operations have rapidly accelerated the process. The bond market knows it. And China knows it.

So how do the Chinese plan to protect themselves? And more importantly, how can you protect your wealth and profit?

First of all, it is important to understand that what countries say they are doing with their currency and foreign reserve holdings and what they are actually doing are rarely the same. Poker players don’t show their hands and use intentional misdirection. In this poker game however, the stakes are in the billions and trillions. So you have to learn to read through the headlines.

China says that they are still committed to their investments in U.S. Treasuries… that they will continue holding dollars… and that gold is not really an option. What else would you expect them to say?

In reality, China has been adding to their gold reserves as fast as they can without driving the price up too quickly. And they have been doing so undercover, through intermediaries. They are also soaking up nearly every ounce of gold that is produced within China. While China is now the number one gold producing country in the world, their production does not hit the world markets.

Diversifying out of their dollar holdings is a tricky process as well. China obviously can’t just dump their dollar holdings overnight. What they are doing instead, is slowly converting their debt instruments and paper wealth into real things… copper, steel, lumber, concrete, cotton, wheat, soybeans and precious metals.

And instead of buying long dated U.S. Treasuries that mature in 20 or 30 years, they are buying instruments with shorter term maturities.

And finally, of course, the Chinese (and other countries as well) are plowing any excess exchange reserves back into their own country to provide economic stimulus. In November, the Chinese government announced a nearly $600 billion internal stimulus package.

This is bad news for the U.S. government bond market. Just as America’s spending goes parabolic and we need to sell more debt than ever, the biggest buyer is walking away from the trading floor.

The Federal Reserve might control short term interest rates, but it is the market that controls long-term rates. And just like any market, this one responds to supply and demand. With a budget deficit of nearly $1.8 trillion this year and soaring deficits as far as the eye can see into the future, there is going to be a glut of supply. And we have already addressed what is happening to the demand.

The Fed’s solution is to step in and buy our own debt, when other countries and institutions are unwilling or unable to do so. But this creates a catch-22. This amounts to nothing more than printing dollars. And the more dollars we print to buy our own debt, the weaker the dollar becomes and the less likely that foreign countries are willing to buy.

In my view, there is only one way this scenario will play out. Get ready for soaring interest rates, hyperinflation and exploding gold and silver prices. It is not going to happen overnight, but I don’t see any way it can be avoided.

It used to be difficult for small investors to use the market to profit from rising interest rates. Today, it is as simple as buying or shorting an ETF. The chart below shows the yield on the U.S. 30-year Treasury bond. In the early 1980s the yield peaked around 16%. It has been falling ever since. As yields fall, bond prices rise, so what you are looking at below is a 28 year bull market in U.S. Treasury bonds.

But pay attention to the last six months…

That spike represents what I believe will mark the end of the bull market in the “long bond”. And it represents the beginning of a new era of rising interest rates.

Certainly, you should own gold and silver and precious metals equities. But you should also consider pairing that investment with a bet against long-term U.S. government bonds. The way to play it is to short the iShares Barclays 20+ Year Treasury Bond Fund (TLT) or buy the ProShares UltraShort 20+ Year Treasury Bond Fund (TBT).

The TBT is an exchange traded fund that returns two times the inverse of the daily performance of the long bond index. Do not buy your entire position all at once. Leg into this position incrementally over the next six months or a year.

To Your Success,

Jon Herring

As interest rates go down, bond prices rise. So all you need is an instrument that rises alongside bond prices to make money.

That instrument is iShares Barclays 20+ Year Treas.Bd ETF (NYSE:TLT)

As you can see from the chart above, after yesterday’s Fed announcement the TLT roared higher. And after making a move that massive – which is quite unprecedented in the bond market – today it consolidated some of those gains.

But don’t let today fool you.

Ben is crazy. And he’s going to do whatever it takes to push long-term interest rates down.

He’s already proven that by announcing a $300 billion Treasury buy-back that will happen over the next six months.

As a result of Bens “crack headed” antics, we should see the TLT reach and even surpass the December peaks of around 122.

If you buy the ETF, that’s a potential 17% move. If you buy the right short-term option, triple-digit gains are definitely within reach.

But Eric says TIPs buyers must be cautious: a prolonged spell of deflation would be devastating to both prices and yields.

More from The Rude Awakening:

Everyone knows that a deflationary deep-freeze is paralyzing the global economy. Everyone also knows, therefore, that inflation is as good as dead. The sellers of stocks know it; the buyers of long-dated Treasury bonds know it; and the sellers of TIPs (Treasury Inflation-Protected bonds) know it better than anybody. When so many financial market participants are certain about anything, a forward-looking investor might want to challenge the thesis…and try to make a few bucks in the process.

The nearby chart shows quite clearly that prices of long-dated Treasury bonds (as represented by the iShares 20+ Treasury Bond ETF – NYSE:TLT) have been soaring, whiles the prices of TIPs (as represented by the iShares Treasury Inflation Protected ETF – NYSE:TIP) have been falling. Most long-dated TIPs have tumbled 15% in less than two months. Evidently, investors want nothing to do with inflation protection, but will stampede to obtain DE-flation protection.

But is deflation such an utter certainty that investors should be scooping up 10-year Treasury bonds that yield a near-record-low 3.11%?  To rephrase the question, is inflation such impossibility that investors should be unloading 10-year TIPs (Treasury Inflation Protected) that currently yield 2.40%, but could produce a vastly greater return if inflation heats up?

We ask these questions, not because we believe a deflationary episode is unlikely, but rather, because we do not believe that an inflationary episode is impossible. Investors in long-dated Treasury securities seem to have convinced themselves that inflation has been “deep-sixed,” not just for the next two or three years, but for the next 10 to 20 years as well.

The cost of taking the other side of that trade has never been cheaper. But TIP-buyers beware!…The other side of the trade is not without risks. A potent deflationary trend would depress the value of TIPs, both in absolute terms and relative to conventional Treasuries.  In such a circumstance, TIP prices could fall… a lot.  At maturity, of course, the TIP-buyer would receive at least “par” for his bonds.  But no investor wants to wait a decade or more to see the return of his capital.

[To better appreciate the virtues and vices of a TIP of security, consider the following brief primer: http://www.treasurydirect.gov/indiv/products/prod_tips_glance.htm]

As noted above, the conventional 10-year Treasury bond yields 3.11%, which is 71 basis points more than the 10-year TIP yield of 2.40%. The TIP-buyer accepts yield penalties like these in exchange for the comfort of inflation protection.

But comparing current yields is only one small part of the calculus that leads an investor to either buy or shun a TIP.  The most important aspect of the comparative analysis is the “implied breakeven inflation rate.”  In other words, what would the average inflation rate need to be during the life of a given TIP to make it a better buy than a conventional Treasury of the identical maturity?

During the last decade, the implied breakeven inflation rate for a 10-year TIP has fluctuated around 2% – meaning, if the inflation rate averaged less than 2% during the life of the TIP, a conventional 10-year Treasury bond would have been a better buy.  On the other hand, if the inflation rate averaged more than 2% during the life of the TIP, the TIP would have been the better buy.

Lately, a very strange thing has happened in the TIP market: breakeven inflation rates have collapsed to all-time lows. The 10-year TIP, for example, is pricing in a razor-thin inflation rate of just 0.3% per year during the next 10 years.  I.e, if the inflation rate averages more than 0.3% per year during the next 10 years, the buyer of a 10-year TIP at today’s prices would be better off than the buyer of a conventional 10-year Treasury bond.  The inverse would also be true.

Let the reader decide, therefore, whether the average U.S. inflation rate will exceed 0.3% per year during the next decade. But before deciding, let the reader also do enough homework about the quirky world of TIP securities to avoid making unintended errors.  One of the easiest – and costliest – errors a TIP-buyer could make would be to underestimate the capital-destroying potential of a severe deflation.  If the Consumer Price Index were to decline sharply for a sustained period of time, the price of a long-dated TIP would also decline sharply.  Furthermore, the current yield provided by the TIP would decline at the same time – a deflationary double-whammy.

Thus, the TIP buyer’s world is very simple: inflation = good; deflation = bad. But therein lies the appeal of these unique securities as well.  Inflation is rarely a good thing for the value of a financial asset, but it is a good thing for a TIP.

When the central banks of the world flood the global monetary system with titanic quantities of credit and currency, an inflationary uptick does not usually trail far behind.  And when the US Federal Reserve pours so many trillions of dollars into the US financial system that an $800 billion bailout seems like nothing at all, an inflationary uptick becomes increasingly likely.

TIPs are risky, but inflation is devastating.

Source: Beat the Rush; Sell Treasury Bonds Now

“So far this year, gold has lost less than 3%,” noted Bill in yesterday’s DR. “But stocks are down 14%.”

That’s cold comfort for many gold bugs — or for anyone whose investment strategy relies on what the pros call “non-correlated assets.” Isn’t one asset class supposed to rise when another falls?

In this regard, 2008 is feeling a lot like 1981: Every major asset class is taking a beating.

The late Harry Browne advocated a “permanent portfolio” strategy — taking the money you absolutely can’t afford to lose and tying it up in equal proportions among gold, stocks, bonds, and cash. The idea is that no matter the external economic condition — inflation, prosperity, deflation, or recession — one of those four asset classes performs well enough to pick up the slack for the other three and you can average a gain of about 8% a year.

But the key word there is “average.” Some years return better than 8%. And on rare occasion, everything gets hammered. That’s what happened in 1981. The four asset classes were down an average 6%. And so far, 2008 is playing out much the same way. As Bill noted, gold is down 3% and stocks 14%. As a proxy for long bonds, the iShares Lehman 20+ Year Treasury Bond Fund (TLT) is down about 1%. Roll over a bunch of T-bills for your cash position, and you might be up about 1%. That’s an average loss of over 8%. And by the reckoning of John Williams at Shadow Government Statistics, consumer price inflation is running about the same as it was in 1981. Ouch.

Of course, 1981 marked a turning point in many regards. Paul Volcker’s Fed was putting the hammer on inflation. We were on the cusp of an epic bull market in stocks. Neither of those appear to be the case now.

By the same token, gold’s bubble had already burst in 1981. And while the world’s central banks did a swell job in the summer of 2008 goosing the U.S. dollar and taking down the price of gold on commodities exchanges below $800… just try buying a one-ounce gold coin for a reasonable premium over the exchange-quoted price: You’ll be waiting weeks for delivery. (Word came yesterday the U.S. Mint is resuming one-ounce gold Eagle sales, but it’s putting dealers on allocation.) At some point, the ticker price will have to catch up to real-world demand.

Even analysts like Marc Faber who’ve given up on commodities (at least for now) still believe it’s worth your while to accumulate physical gold. And for some additional gold ideas, check this out.

Source: A cruddy year — for every asset class