There are major trends developing that are so obvious, sometimes I question the intelligence of investors who still have their blinders on. Gold is one major trend that I have publicly profited from despite constant resistance from the mainstream. If you think the trend in gold has reached its peak, then I will happily sell you some puts. The next correction in gold will get everyone beared up like it always does. I will be buying just like I have in every other major correction.
The other major developing trend is the collapse in government bonds. We are in a debt crisis and confidence in our government is collapsing. People will flee all things government, including Treasuries. Now if capital flees government bonds, it must find a place to park. One of these places is obviously gold. The other is stocks (this partially explains the major run-up in stocks that I told you was coming). The third place capital will flee to? Corporate bonds.
Corporate bond yields are falling in a seemingly paradoxical move. After all, most people would agree that the global economy is stalling. So why is capital starting to find its way to corporate bonds and what does this tell us about the future?
The bond market is so critical to understanding where we are headed. Whenever there is a crisis, investors always react by buying government debt since it is perceived as quality. Of course it makes absolutely no sense for investors to flee to government debt in a sovereign debt crisis, but they do it anyway. Nontheless, I am positive the flow of capital into government bonds will eventually grind to a halt.
If you want to think like the smart money, you have to understand what rising and falling Corporate/Treasury spreads indicate. Talking heads on TV will tell you that this evidences a robust business environment. This is nonsense. At the end of the day, capital is fleeing the public sector in a big way. The smart money is losing faith in the government’s ability to resolve this debt crisis. As I’ve said before, I would much rather be invested in a private company that produces tangible assets than in government bonds. And it’s not even close. But this doesn’t necessarily mean I am bullish on the economy as a whole. I’m talking about relative returns here.
I personally couldn’t care less that 10-year Treasuries are trading at 2.5%. Obviously there is demand for our debt. But as an investor, I want to know where the demand is coming from. Why is this important? Well allow me to offer you an analogy. Think back to 2 years ago when mortgage rates were on the decline. Wasn’t everyone telling you it was a once-in-a-lifetime opportunity to buy a home? Wasn’t everyone picking a bottom in housing? I scoffed at such notions because of the overhang in inventory and the collapse in forward money. Furthermore, it was direct government purchases of agency debt that forced mortgage rates lower. In other words, the markets were manipulated. People tend to think the government is all powerful and that they can control markets. Well then I must ask you why home prices haven’t risen in response to record low mortgage rates. Focusing on mortgage rates alone is a truly myopic approach to viewing the housing market.
In the same way, people are mistaken in focusing merely on Treasury yields. As I’ve said, we must also consider who is buying our debt.
I recently came across a chart from Bloomberg that shows a troubling trend: China has begun to unload our debt, and this has forced the U.S. to step in and purchase securities directly. Debt is currently rising at a clip of over 10% a year, so we need to find more and more investors for our debt as the global economy stalls. This is a Herculean task. It is not going to happen folks.
The writing is on the wall. My money is where my mouth is. I’m ready for the inevitable. I suspect most people will come out of this crisis in much worse shape. Very few see what’s coming. If I couldn’t touch my portfolio for 5 years, I would be long gold and stocks and short government bonds. The markets are screaming to me that these are the trends of the future. I believe monster once-in-a-generation moves in both directions are coming. Are you prepared?
This post has been republished from Moses Kim's blog, Expected Returns.
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