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The Forces of Deflation Are Stronger Than People Realize

16 comments  |  by: Colin Peterson December 19, 2008  | about: TLT
   
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We need to figure out the inflation vs deflation debate.

A few months ago, I decided that short term we would have deflation. I had bought long duration treasury (TLT) calls. Treasury yields have been crushed. I wish I had bought more. (The calls increased in value tenfold.)

Now the treasury move is approaching parabolic: http://chart.finance.yahoo.com/c/3m/t/tlt. Treasuries have no substance. Economic textbooks say that they need never be repaid. Clearly the fundamentals are terrible. Parabolic move plus bad fundamentals equals inevitable crash.

We can make another huge return, betting on the treasury crash, if we can time it right. But I think the forces of deflation are stronger than people give credit for:
http://web.mit.edu/krugman/www/deflator.html. Also, there are still too many treasury bears for the crash to happen yet.

Comments encouraged.

About the author: Colin Peterson
Colin Peterson picture
Colin Peterson is a management consultant with experience in a variety of industries including real estate development and investment. Mr. Peterson writes Credit Bubble Stocks, where his analysis focuses on finding and selling shares of overvalued companies whose collapse may be imminent. Visit... More
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Comments on this article
  •  
    If the Fed can throw unlimited money at long-term treauries, as it recently hinted it would do, it can keep up the price.

    I suspect that word of the Fed's intentions leaked out months ago and was the factor behind the irrational rise in the long-bond price.
    2008 Dec 19 09:50 AM Reply
  •  
    I agree with both of you. I have initiated one short position in TLT. so far I am wrong in timing it. However I believe with Deflation being the primary concern TLT run can go longer. As and when SNP bottoms, I think around 600.. Inflation will start taking the center stage and then TLT will be start fading... That may start as early as third quarter of 2009.

    By no means I am an expert nor I do I claim to be one. I am a infant on the block and appreciate an opportunity share my views.

    Thank you!
    2008 Dec 19 10:17 AM Reply
  •  
    Treasury bonds are being manipulated by Unkle Scam. Yes, that can go on for a while, but at some point we will have a whiff of inflation, market stability, or even our Unkle deciding that buying T-bills is something he doesnt need to do (kind of like randomly deciding not to spend the TARP on what they orginally asked.) I think anyone long government bonds right now is rolling some serious dice for not a lot more upside and a huge potential downside.

    As a side note, perhaps it's an elaborate scam by our dear Unkle to get mortgage rates down by implying that they will be a buyer of bonds which tricks market participants into bubbling up the prices so they dont have to stick it on their balance sheet. Of course that would mean they have forethought.

    Have they actually bought any T-bills yet? Can they buy the T-bills that Asia refuses to buy?
    2008 Dec 19 10:39 AM Reply
  •  
    Thank you, Roger.
    Now the treasury bubble finally makes sense to me!

    It's not fed's buying that caused the bubble but speculation that he is likely to do it at some point. Which I think would be dumb at the current prices, I hope they'll buy some high-grade corp bonds instead (those are going up too by the way). Either way injects money into the economy but the latter approach makes much more sense.

    On Dec 19 09:50 AM Roger Knights wrote:

    > If the Fed can throw unlimited money at long-term treauries, as it
    > recently hinted it would do, it can keep up the price.
    >
    > I suspect that word of the Fed's intentions leaked out months ago
    > and was the factor behind the irrational rise in the long-bond price.
    2008 Dec 19 06:22 PM Reply
  •  
    "In short, if you really believe that deflation is now a global threat, you should also believe that only policies that lie outside the realm of what is conventionally regarded as responsible will contain that threat. And because unconventional thinking is not what one expects (or, in normal times, wants) from finance ministers and central bankers, there is now a real risk that deflation will indeed become a global scourge."

    colin, i love this quote from the krugman link.
    2008 Dec 20 12:16 AM Reply
  •  
    Everybody and nobody can predict the market. Obviously one day the stock market will go to zero. Long term we are all ded and so the planet, but nobody
    knows when. I don' think the treasury will fail, becouse the central bank can always print money. Inflation and deflation will ebb periodically. The real question is timing as you said.
    2008 Dec 20 08:44 AM Reply
  •  
    So, how about buying TBT and selling covered calls against it?
    2008 Dec 20 02:48 PM Reply
  •  
    If you want virtually all of the downside risk and very little upside (your position will be called away at the strike price if it advances),go ahead. Seems like a poor risk/reward to me.


    On Dec 20 02:48 PM henarl wrote:

    > So, how about buying TBT and selling covered calls against it?
    2008 Dec 20 03:43 PM Reply
  •  
    TLT reminds me of oil a few months ago. Everybody knows its unsustainable but no one can bet against it because they instantly lose money. When the worm turns it, like oil, will be fast.
    2008 Dec 20 03:45 PM Reply
  •  
    jepittman: Downside risk? How much lower do you think the yield on long treasuries can go and still have ANY buyers?
    2008 Dec 20 04:42 PM Reply
  •  
    Unkle's plan must be to push Treasury bond yields down so far that investors will jump that ship onto the stock market, the bear will be over and happy days will be here again. PE's can go to 50 and that is still 2%.
    2008 Dec 20 07:53 PM Reply
  •  
    secmaven, the plan is to cause the majority of money market investors to flee from zero return to bank CDs, which are selling for 3-4% yields, thus recapitalizing banks. It is all about banks, not stocks.
    2008 Dec 20 10:05 PM Reply
  •  
    Yes treasuries are too high, but with the threat of the Fed buying treasuries and its unlimited buying power, shorting treasuries seems very risky to me.
    2008 Dec 20 11:07 PM Reply
  •  
    We'll see what ole' NY Times Paul says when inflation hits with a vengence in early 2010. Then again, he may not have a forum if "all the news fit to print" dies a slow death under Pinky Sulzberger.
    2008 Dec 21 12:02 AM Reply
  •  
    TBT will pay off nicely eventually, we just don't know when. It's possible that the Chinese and the Japanese have basically said that they're not buying government paper any more and that's what really driving this seemingly completely irrational Fed behavior. Once the exodus starts, it's going to get ugly.

    The "unlimited" balance sheet is more theoretical than practical. Despite the inherent second derivative or counter-party risk in CDS that mask the true default risk of the underlying asset, the prices are somewhat informative. CDS on US paper continue to trade up in price. Eventually the true risk of these assets will express itself in the price/yield that the market requires.

    When you combine the current yields with a potentially depreciating dollar, it's a one-two punch that creates intensely negative real returns for foreign investors.
    2008 Dec 22 02:30 AM Reply
  •  
    agree re: the Treasury bubble but you've got plenty of time to ease into the short treasuries position (through long TBT or short TLT). fed signaled it would lean towards buying treasuries in last statement so should be interesting.

    we wrote about the rationale behind shorting treasuries here: www.marketfolly.com/20...
    2008 Dec 22 09:54 AM Reply