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Guest Post: Moving into Bonds - From Frying Pan to Fire

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Sat, 09/04/2010 - 21:10 | 564130 deadparrot
deadparrot's picture

And the worst thing about a bond market implosion is there is no safe harbor. How do you think real estate and equities will be doing when interest rates are in the low teens?

Sat, 09/04/2010 - 21:53 | 564156 Eternal Student
Eternal Student's picture

People have a hard time with the concept of capital destruction, even though it's a required part of our system, and it's happening every second. They have an especially hard time when it's their capital.


Sat, 09/04/2010 - 22:59 | 564231 traderjoe
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It's one thing to own an individual bond that you can hold to maturity (not that I think that will happen). 

Another thing when you own a bond fund that tries to maintain some constant duration level. Yikes. 

Sun, 09/05/2010 - 11:35 | 564590 deadparrot
deadparrot's picture

This is really a difficult scenario for insurance companies. They have the vast majority of their investments in fixed income. Thanks to this Fed-engineered bond bubble, prices are great. Too bad insurance companies don't have the option of selling high. They have to keep plowing proceeds from maturing securities into bonds with ever-lower yields. I'd be popping antacids like candy if I was an insurance company's portfolio manager right now. What choice do they have but to buy the junkiest investment-grade securities available AND STILL fall short of their target yield.

Mon, 09/06/2010 - 00:46 | 565458 ToNYC
ToNYC's picture

Fools and their money are soon parted.

Sat, 09/04/2010 - 22:37 | 564204 Dr. Sandi
Dr. Sandi's picture

Here's a thought.

Buy physical gold and silver. Paper is for personal hygiene.

Sat, 09/04/2010 - 23:49 | 564275 Spitzer
Spitzer's picture

haha, how long have you been reading ZH ?

Sun, 09/05/2010 - 01:04 | 564329 pitz
pitz's picture

Some equities are countercylical.  For instance, the Canadian market tends to outperform during a rising interest rate environment, against the US market.  This is because, disproportionately represented amongst Canadian stocks are those in oil and gas, mining/gold, and banks that have positioned themselves to have little or no interest rate risk.

The 'stock market' is not a monolithic thing.  Certain countries are positioned better than others. 

Sun, 09/05/2010 - 10:21 | 564538 Young
Young's picture

Oh so you have a more aggressive PPT than the states now?

Sun, 09/05/2010 - 14:18 | 564809 pitz
pitz's picture


No, the reason for such is that the inflation that is co-occurs with depreciating currency and depreciating long-term bond prices,  tends to be very beneficial to resource-based economies such as Canada. 

Sun, 09/05/2010 - 01:10 | 564334 Auric Goldfinger
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Deadparrot alludes to what I suspect is a common dilemma for average morons like me...

The fuckers have me by the short-hairs. Got largish 401(k) with equity, bond, and treasury options- and that's it. Too chickenshit to cash-out and PM IRAs don't get it done as I prefer physical. 

How about we dial down the ridicule a little (I'm looking at you, Spitzer) and give a little help to those who have only recently taken the Red Pill. 



Sun, 09/05/2010 - 09:36 | 564516 tmosley
tmosley's picture

Well, you're either going to have to get over your fear of cashing in your retirement fund, or find some entity that you trust implicitly and buy their paper.

The only alternative is to see if you can borrow against your retirement fund and use that to buy physical.

Sun, 09/05/2010 - 10:49 | 564554 trav7777
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I think a bond collapse is further out, if at all.  Yields cannot rise at this point, there is no demand at 5%, what demand will there be to borrow at 15%?

Roll your 401 into self-directed.  Then you can buy whatever you want.

There is no 401 safe harbor from bond crash, because none have a true cash option and the MMAs can buck-break.  I'm in GSE sponsored debt and miners...there are some trades to be had on foreign funds, but the volatility out there on carry trade targets is often severe.

Sun, 09/05/2010 - 14:20 | 564813 pitz
pitz's picture

No demand at 5%??  LOL!  What ya be smokin today Sir? 

Sun, 09/05/2010 - 15:24 | 564925 dogbreath
dogbreath's picture

I recently met someone who cashed his 401k.  He was informed by some apocalyptic christian publication - go figure.  Anyway his 60k turned into 43k after taxes.  His co-workers who thought he was crazy and didn't cash out like he reccomended have 12k remaining. 

Sun, 09/05/2010 - 12:34 | 564635 quintago
quintago's picture

that was a lot to write to explain that when people stop buying prices fall

Sun, 09/05/2010 - 12:57 | 564669 FoodTiger
FoodTiger's picture

Safe harbor?

What about going into Money Market funds?

Sat, 09/04/2010 - 21:18 | 564134 AUD
AUD's picture

As I understand it, a small decrease in yields can lead to a large 'capital' gain.

There is room for Gov. bond yields to fall. I wouldn't agree that corporate bonds in general are a bubble though.

Until people realise that the bond is the dollar (the dollar is a bond) & thus a bond rising in price against the dollar is rising in price against itself!, the charade will probably continue.

Sat, 09/04/2010 - 22:36 | 564199 DoctoRx
DoctoRx's picture

Presumably you refer to a dollar BILL.  The dollar as commonly referred to is a bill, not a bond, and it is a special type of bill that pays no interest.  MZM.  And unlike a bond, which is a form of a derivative as compared to currency ("money"), the dollar bill is the "real" deal.

But all this is O/T re the post above.  So what he has shown is that money chases returns.  And sometimes it is a leading indicator.  What you can't tell from this chart though is the to-date secular bull market in interest rates and whether it has finally ended.  Should investors/traders buy the next bump-up in rates?  Was the NAZ overpriced Jan 1, 1999?  Did it more than double in the next 14 months?

So, AUD, perhaps the bond bull either has died of old age and Timmy's (et al) excesses, or it hasn't died yet; but the realization that a dollar bill is technically a "bill" or a "note" (Federal Reserve obligation) I doubt will be required for the bull to turn into a bear.  Perhaps it will simply end when JPM and GS are short enough bonds.


Sat, 09/04/2010 - 23:55 | 564278 Spitzer
Spitzer's picture

what he meant sir, is that that bonds back the dollar. When bonds crash, the full faith and CREDIT will be lost.

Sat, 09/04/2010 - 21:27 | 564140 bugs_
bugs_'s picture

Especially muni bonds.  Oh the pain coming down!

Sat, 09/04/2010 - 22:57 | 564228 traderjoe
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There will be no bids for general GO debt of troubled muni's, especially as the insurance companies start going BK. Defaults, defaults, and more defaults. Capital destruction. 

Sat, 09/04/2010 - 21:54 | 564159 RockyRacoon
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When in danger, worry, doubt,
Run in circles, scream and shout.
Burma Shave

Sun, 09/05/2010 - 07:57 | 564466 ExistentialSkeptic
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Love it Rocky.

Sat, 09/04/2010 - 22:16 | 564180 Belrev
Belrev's picture

With unlimited credit (money) supply made available by US Federal Reserve (and other central banks for that matter) I am puzzled to see how the price of money (interest) can go very high. It surely fluctuates but for it to jump by any measurable amount there must be a shortage of capital. And who cares about foreign buyers, the FED can step in and buy USTs instead to keep them bid up. Incidentally China has been reducing their net UST holdings and as we all see bond yields are near record lows. So it seems to me that the foreigners dumping USTs and causing a collapse is as much a myth as the decoupling theory.

Sat, 09/04/2010 - 22:54 | 564223 traderjoe
traderjoe's picture

That's the sort of logic that occurs at the end of bubbles - that "this time will be different". Yes, the Fed can buy UST's. Yes, it could even buy all of them being issued. Could even buy all of them outstanding. The Fed can print unlimited money. 

But can it? Confidence in a fiat currency is lost slowly at first, quickly in the middle, and shockingly quickly in the end. In Weimer Germany, hyper-inflation blossomed in 2-4 months. It slowly built over time, and then exploded. 

If the Fed was buying all of our UST's and everyone knew that NO ONE else wanted them - what would happen to their prices? Interest rates? Can the US afford to finance the debt at 10% interest rates? What happens when the average citizen wakes up to the fact that the Fed is privately held (I'm not holding my breath on this one)? [How about what happens people wake up to the fact that the US Treasury <could> issue their own money without having to pay interest? I'm no MMT'er, but that would be the only way to actually legally issue currency - especially if it was backed by PM's.]

Back in the financial panic of 2008, I was buying corporate bonds for 50 cents on the dollar. Levi's, RCL, Smithfield, Dole, etc. There were no buyers. 

Can't happen again? Can't happen to UST's? You just wait. Grab some popcorn. It's going to be a doozy. 

Sun, 09/05/2010 - 08:35 | 564477 A Proud Canadian
A Proud Canadian's picture

What happens when the average citizen wakes up to the fact that the Fed is privately held (I'm not holding my breath on this one)?

And, why would the Fed, being privately owned by US and European banks buy every UST when it becomes clear to them that it isn't in their interest to bankrupt themselves to save the US?   The Treasury may have to go down with the ship but the Bank owned Fed would likely save themselves at some point before self destructing.

Sun, 09/05/2010 - 09:45 | 564520 tmosley
tmosley's picture

Uhhh, you do know that the Fed can print money, right?  It can't go bankrupt.  It can bankrupt the economy, but the Fed itself always has access to as many dollars as it wants.

Also, they already have gold, so I doubt they would complain about it going up in value once they see the writing on the wall (or they no longer have their gold, and they are just trapped and/or don't know what they are doing, as they are run by economic witch doctors).

Mon, 09/06/2010 - 04:10 | 565534 1984
1984's picture

Sure they can print all they want and try to buy up all the gov't papers.  But what would happen to prices of everything else?  Weimar rings a bell?  Maybe Zimbabwe?

Tue, 09/07/2010 - 06:03 | 566809 A Proud Canadian
A Proud Canadian's picture

I realize that they can print out of thin air but, why wouldn't they, at some point se that that would lead to hyperinflation ....wouldn't the self preservation instincts of the Rothschild's, UBS elements of the Fed trump the urge to "save" the US?

Sun, 09/05/2010 - 21:15 | 565268 greyghost
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Sat, 09/04/2010 - 22:54 | 564221 Gordon Freeman
Gordon Freeman's picture

Why do these articles always claim that bond traders are looking for "safe yield"?? It's simply a macro play on the deflationary collapse of Western Civ--and so far, it's been paying off in spades, for all this "dumb money".  Safe yield, my ass...

Sun, 09/05/2010 - 00:00 | 564286 Spitzer
Spitzer's picture

So when this deflatinary collapse happens, who pays the interest on the bond ?

Where is all the tax revenue going to come from when "western civ " collapses ?

The Nasdaq paid off in sapades for a while too, back in 1999.

Sun, 09/05/2010 - 00:57 | 564324 pitz
pitz's picture

Yeah no kidding, the modern version of 'deflation' assumes that governments can remain extremely irresponsible, and that the welfare state is sustainable, worn out and largely depleted industry (worldwide) be damned.

Really, 'deflation' is just a ludicrous plot by the bankers to get you to invest all your money in bonds, and pay back debt.  They know what's coming, that's why they're on the opposite end of the trade.

Sun, 09/05/2010 - 01:24 | 564342 camoes
camoes's picture

contrarian investing bitchez - leveraged 200% in equities baby...papa need a new pair of shoes!

Sun, 09/05/2010 - 01:30 | 564343 pitz
pitz's picture

Funny how the average man on the street would call you 'insane', yet think nothing of buying a house with a 10% downpayment (=leveraged 1000%!).

I'd argue that equities are safer than owning a house over the long term. 

Mon, 09/06/2010 - 23:31 | 566545 camoes
camoes's picture

That's so true Pitz, people think it's normal to be levered 9:1 with an illiquid and non-divisible asset such as a house, but they think you're crazy to be levered in a highly diversified portfolio (mine is diversified along US, eafe, emerging markets, real estate, etc,  etfs). So even if I levered close to a margin call (which I don't, I keep leverage with a wiggle room before it ever got close to margin calls) and got a margin call, at most I would have to liquidate part of my portfolio, while if a house gets underwater or you can't make payments (equivalent to a margin call), you have to liquidate the whole house - at least I never heard of just giving up a room or a bathtub to the bank.

The craziest is to actually have most of your wealth invested in one asset class, be it bonds, houses or equities (among those, I'd go with equities, cause they are real claims in assets which may include, real estate and bonds, commodities, products, etc...)

I even talked to people who say margin is risky, but then they use options to "hedge" risk. Options are so much worser than margin, cause you have a pre-defined margin call date, and if the market is against your position at exp date, tough luck, you lose everything you invested!

Anyway, maybe I'm a risk lover, but I still think it's safer to be short a fiat currency with benny money printing and long equities than putting money in us treasury bonds, but I guess I understand the baby boomers who are scared shitless from equities and don't have the option to wait for equities to recover in the long term...

PS: This same people also think us and developed equities were safe and emerging markets risky, but if you look at long term past and future perspectives, disconsidering short term volatility, emerging were the safest and best performing assets in the last 10-20 years (if you're highly diversified among countries and equities of course, I'm comparing indexes, not individual companies or countries)

I just feel sorry for the people who got raped in real estate and equities, sold off during the crisis and now are being fooled again by investing in long term bonds.



Sun, 09/05/2010 - 01:32 | 564346 Village Idiot
Village Idiot's picture

OT:  Avatar who junked VI on the Dylan Grice post, i have a friendly message for you. Read it.

Sun, 09/05/2010 - 15:55 | 564957 Village Idiot
Village Idiot's picture

"OT:  Avatar who junked VI on the Dylan Grice post, i have a friendly message for you. Read it."


message updated.

Sun, 09/05/2010 - 05:54 | 564438 GreatTimeToBuy
GreatTimeToBuy's picture

so should you short bonds?

Sun, 09/05/2010 - 08:53 | 564489 tom
tom's picture

Only if you're sure the Fed won't go ahead with QE2. Bonds can go bad either by prices dropping (if there's no QE2) or inflation (if there is QE2). Going long you get killed either way. Going short you collect on the former, but still get killed on the latter.

Sun, 09/05/2010 - 08:59 | 564491 Gordon Freeman
Gordon Freeman's picture

Yeah--where are the big leveraged bond shorts?  Doesn't work so well, does it?

Seriously, what is going to keep the long bond from 3%, under the circumstances we have, today, and for a very long time?  These same circumstances are not exactly manna for equities...

Sun, 09/05/2010 - 09:28 | 564511 thepigman
thepigman's picture

I call BS. Investors
are returning to the
the pre-equity cult
mix of 50-50 stocks/
bonds because stocks
are at least 30% overpriced on a GAAP
earnings basis and
delivered 0% returns
over the last 10 years. Even so, most
folks still hold too
high a proportion of
stocks today (about
70%) relative to bonds. There's a long way to go on bonds just to get back to a saner pre-1982 mix.

Sun, 09/05/2010 - 09:49 | 564524 thepigman
thepigman's picture

Your great grandpa
knew equities were a
scam. What goes around

Sun, 09/05/2010 - 09:55 | 564526 tom
tom's picture

In theory yes, but it's not only a question of how much capital is looking for safer returns. When too much spending is brought forward, and too much nominal wealth is in the form of claims against future production, and nominal wealth exceeds the prospective productivity of the population and its real assets, one way or another that excess nominal wealth will get wiped out. First, equity implodes and safety-seekers pile into bonds, but if that's not enough, and in our case it's certainly not enough, then later the bond holders must get crushed, either through default or inflation.

Sun, 09/05/2010 - 10:35 | 564543 thepigman
thepigman's picture

Fair statement. But I'll jump that
bridge when we come to it. For the
moment, most of the "bond bubble" calls are coming from sell side equity
strategists trying to herd the sheeple
back into stocks for a final shearing.

Sun, 09/05/2010 - 10:20 | 564537 Young
Young's picture

Oh so you have a more aggressive PPT than the states now?

Sun, 09/05/2010 - 10:42 | 564546 Leo Kolivakis
Leo Kolivakis's picture

Let's get one thing straight: if you're absolutely convinced we're heading towards a protracted debt deflation cycle, keep buying them long bonds, they will outperform everything else. If on the other hand, you think stagflation is in the cards, then you will get burned on nominal bonds. Only inflation-sensitive bonds will protect you if stagflation occurs.

Sun, 09/05/2010 - 22:20 | 565341 pitz
pitz's picture

That is, if CPI (or whatever inflation index used) is actually reported correctly.  And why not just buy equities instead if you believe in the scenario where the inflation-adjusted bonds are going to have value?  A 1% real yield on TIPS is like a P/E of 100 on a stock (but you can buy the market for far less than 15X earnings right now!).

Sun, 09/05/2010 - 10:43 | 564547 CrashisOptimistic
CrashisOptimistic's picture

I continue to think you guys, especially in gold, have this wrong.

I'm generally okay with the rationale of "historical preservation of wealth" theory for gold, though I am strongly inclined to believe it will prove wrong for the simple reason that there is no history of a global civilization that falls from lack of oil.

But beyond that, here's the thing.  Mortgages default.  In the trillions.  That's not an increase in money supply.  That's a decrease.  When the Fed buys bonds to hold their price up, and does so every single time there appears to be a risk to the bonds, they are not "flooding the world with fiat currency and debasing its value".  They are not ADDING.  They are REPLACING.  

The housing collapse eliminated net worth.  It eliminated dollars from existence, and this will go on until starvation from oil scarcity sets in.  As that money is erased from the universe, the Fed is printing to replace it.  

Replacement is not going to destroy the value of the money so that gold emerges triumphant.  Replacement is just going to buy time until oil, and then food, disappears.

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