That was one heck of a reversal in bonds today off a beautiful double bottom Wednesday and Thursday. Here’s TLT:
The move was so extreme for bond-land that I sold all of my June 90 calls bought under 91, though I’m holding my unlevered TLT.
The dollar extended its decline, though it is looking every bit like the terminal stages of a panic. Just look at the spike tops being formed in the Euro, Pound and silver. I’m also eying crude suspiciously, though the rally has not quite formed a spike.
Even people who should know better are starting to post nonsense about imminent hyperinflation and panics out of the dollar. The past few trading sessions Bloomberg has been plastered with articles about the threats to T-bonds and the dollar’s reserve currency status. Both the news and sentiment flows suggest a near-term bottom for the dollar is approaching rapidly.
LOL, Nassim Taleb of “Black Swan” fame is starting a hedge fund to speculate on the imminent central banker mass-suicide-by-hyperinflation:
http://climateerinvest.blogspot.com/2009/06/taleb-makes-hyperinflation-bet-and-why.html
Hmm… so his returns haven’t been so hot, other than a big score on puts last year in some funds, though maybe not even with his own personal dough. Seems like his real score was in growing assets under management.
BTW, I’m back in with more TLT calls bought at today’s low. Tight stop, in case the sell-off continues.
Lots of big-name bears are making the inflation bet now. John Paulson and David Einhorn have gone heavily long gold this year.
It is rare to see someone make two big scores in a row. These guys were winners because they were contrarian at the height of a mania — now they are going with the crowd.
On Taleb’s fund, this from the WSJ today:
“The new strategy, designed by Mr. Spitznagel, aims to post big gains if inflation and interest rates take off as they did in the 1970s. Universa will invest in options tied to commodities such as corn, crude oil and copper, as well as options on stocks such as oil drillers and gold miners.
“We think these things are going to see massive volatility,” Mr. Taleb said in an interview.
The fund will also bet against Treasury bonds, which tend to weaken in inflationary environments.”
On Market Folly, it was explained that a majority of Paulson’s gold bet was due to demand that his fund issues a share class denominated in gold.
I think going short on TIPS (not plain vanilla Treasuries) might have a risk/reward. My reasoning: higher deficits would lead to higher interest rates. The reason that JGB yields were low is because Japan had a trade surplus, a large private savings rate, and corporations were suffering from a balance sheet recession so they didn’t take on credit which would compete with government borrow. Remember that when Treasury bonds were yielding two percent in the 1940s, the US had a high savings rate of above 20%. (here are nice graphs on the savings rate).
Regarding TIPS, people are recommending them as a reflation trade, and they are not pricing in inflation. Furthermore, while their intent is to protect against increases in the CPI (the common “perception” of inflation,) they do not protect against real interest rate increases from decreased savings and global sovereign deficits.
Ironically, market participant’s inflationary expectations (right now) are actually a deflationary force since they fuel reflation trades (particularly long oil) and a fear of long-term nominal assets. The former reduces consumer buying power because consumers have to allocate more of their income on a relatively inelastic expensive, while the latter reduces the already weak incentives to buy houses, which would cause the already overvalued home equity to drop faster and force a lower market clearing price to sell houses. Also, higher interest rates coupled with a balance sheet recession would make long-term government securities (relatively) attractive compared to most equity investments. Since consumers lack purchasing power, and are frugal with whatever little purchasing power they have, equity would not generate significant cash flow, and that the debt from the boom phase is a potential risk which should increase discount rates and lower the value of equity. In contrast, a 10 year Treasury at the low nominal rate of 3.5% has low risk (relative to equities) and offers a high real interest rate. (On another note, I see TIPS being used as an inflation hedge, and I do not see how inflation [defined by the CPI] would rise in this environment. [But it doesn't really matter in the short term; long TIPS did extremely well as a reflation trade. Perception matters too.] It seems TIPS are more of a bubble than nominal Treasuries because TIPS do not protect against high real interest rates caused by low savings and huge government deficits as it only offers protection from an increased CPI. In Japan, inflation linked notes underperformed relative to ordinary JGBs.)
That is my thinking for shorting TIPS and it seems somewhat contrarian. Do you like it the idea?
Mike, what do you think of deflation and hyperinflation? Do you share my sentiments?
Interesting, even Prudent Bear’s Doug Noland is now speculating on the possibility of a quick global recovery and disappearance of deflationary pressures: http://www.prudentbear.com/index.php/creditbubblebulletinview?art_id=10234
Remember, hyperinflation is a still realistic possibility. Remember the power of human delusion. Remember that people lie to themselves so they can be better liars to others. Bernanke sincerely believes in Keynesianism/monetarism.
I thought the case for a deflationary spiral was convincing. I thought the massive overpopulation, overcapacity, and the effects of the proliferaton of “neoliberal” policies would drive the prices for everything down. I do not know for sure if this rally is reflation or more of an anti-dollar bias, but currencies such as GBP and NZD (perhaps it was just tagging along for the ride with AUD), which have horrible fundamentals, rallied too. I thought the commodity rally (particularily on energy) would have deflationary effects.
For some fundamental news, deflation would be the unequivocal outcome without government intervention. Here is a great graph from Brad Setser.
http://blogs.cfr.org/setser/2009/05/31/more-government-borrowing-doesnt-necessarily-mean-more-total-borrowing/
Populist political forces lead to deflation if they were allowed to play out. For example, read Patrick Wolff of Clarium analysis. (Although Clarium got their ass handed to them in the second half of last year, and are treading water this year. Their deflationary trades did not work out well. It is still my favorite hedge fund)
One another note, I am one of those The Limits to Growth types who rants about controlling overpopulation and reducing consumption (I got banned from a Catholic forum for talking about Paul Ehrlich), and deflation seems to be one way of faciliating this. Unlike Paul Krugman, I could at least see some positive effects of deflation.
Maybe we would get a replay of 1937 if populist forces take over.
Graphite — That is interesting about Noland. I seem to remember that the Prudent Bear guys have been dollar bears for a very long time, however, so they may be some longstanding anti-US bias to their stance. Now if Mish or Prechter would turn bearish on the dollar and bullish on emerging markets, that would be something.
I tend to think that we have seen most of the price move we are going to get in this bounce in global equities, though a lot of commodities have room to run.
Also, this period can last as long as 8 months, judging by some other dead-cat bounces within big bear markets.
I’ll post this link by Paul Krugman.
Besides the issues with the source, one should consider when that was written. It was written in 1999 during the NASDAQ boom, and no one was fearing a fall in the dollar. The atmosphere was different now.
http://www.pkarchive.org/cranks/SorosLost.html
http://www.smartmoney.com/breaking-news/?story=20000106070916&print=1
I worship Soros and Druckenmiller.
I do not know if there is any point to this (maybe it provides a nice compare and contrast between two environments), but Druckenmiller made a contrarian bet and got wasted. Eventually, he did recoup his losses (by going long on the Euro and short on NASDAQ) by going long on the NASDAQ during the late bubble in the summer and fall of 1999 (knowing that is was a ponzi scheme). Later, he got killed by the tech selloff by mistiming it by holding on to his long positions too long.