Friday, November 21, 2008

Bookkeeping: Initiating Ultrashort Lehman 20+ Year Treasury (TBT)

Is it time to short bonds? A growing consensus says yes - as long as the world does not end in the next few days/weeks. Price and yield on bonds work in inverse relationships - as price goes up, yields go down... and prices of bonds have shot through the roof as demand surges. People are scared and hiding in bonds. I heard Rick Santelli say last night the movements he is seeing are not like anything he has ever seen in terms of magnitude, direction, and quickness of movement. We can say that about everything in this market.

Many places I read have been postulating this thesis the past month or two - but with the huge drop the past 2 sessions I think now is a better time to strike. The easy way to play is to short iShares 20+ Year Treasury Bond Fund (TLT) - or if, like us, you cannot short individual names to buy the Ultrashort Lehaman 20+ Year Treasury (TBT).

Hedge fund manager Doug Kass just got in this trade the past 48 hours as well via shorting TLT (RealMoney subscribers can read why here)

a once-in-a-generation short opportunity might now be occurring in the fixed-income markets. My experience is that the magnitude of Thursday's price rise is the sort of occurrence that ends an asset class's move.

It is the essence of the anti-implosion trade and a statement that, among other things, oil will not remain under $50 a barrel and that, at some point in the near future, order will return to the world's markets.

I am going to join him - with one caveat. This market is acting poorly and unless we regain S&P 770 in short order I can more downside, which could lead this trade to continue to work against those are in it. So I'm not going to begin a moderate position and then if the stock market recovers, the demand for bonds should ease. But if we have another crash upon a crash this will move against us.

There are also some very good reasons to own this for the very long run if you agree with some of our long term thesis - they span the same reasons that eventually the US dollar will crumble. As the US government layers on more debt, the risk to said government increases. [Nov 12: CNBC Europe: USA May Lose Its AAA Rating]
[Apr 15: Could the US Lost its AAA Rating?] [Jul 28: US Budget Deficit to Half a Trillion] To compensate for said risk, creditors will demand higher yields - and prices shall fall. And we shall be creating many many treasuries in the US to pay for all the bailouts we still have to work through (I see at least a half a trillion "New Deal 2.0" stimulus plan coming in early 2009 on top of all the other measures we are doing)

So this has both short term and long term catalysts - however in the very short term as people avoid all risk, they are going to what they deem the safest thing on the planet, which they feel are US Treasuries.

As you can see from the chart, after trading in a range of $56 to $65 (a beautiful range to trade) for months, a level many commentators were saying would be an excellent entry point - this ETF has fallen off a cliff the last 2 sessions, giving us an even more attractive entry point in the $51s. We're starting with a 1.7% stake and will save powder in case that "fall off the cliff" scenario in equity markets plays out next week. Again, if there is another bone chilling drop and we see S&P 600s range next week, I could see this ETF falling even further as there is even more panic and "flight to safety" but we are at the point now where people are close to paying the US government (instead of vice versa) for the right to own 3 month Treasuries...

Ultrashort Lehman 7-10 Year Treasury (PST) is another option but the longer dated the bond the more interest rate sensitive it is, hence why we're going with the 20+ year.

Long Ultrashort Lehman 20+ Year Treasury in fund; no personal position (yet)

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