Why I Hope You Didn’t Buy Treasuries Yesterday

Includes: AGG, FIVZ
by: Kevin McElroy

Yesterday I urged you to sell Treasuries, and my timing couldn't have been better. Just hours after I made my announcement, a Bloomberg story shed more light on the Treasury market. The article reported:

Treasuries gained as the government's $35 billion sale of five-year notes drew the lowest yield since the government began quarterly offerings of the securities in 1976.

I've bolded the above statement because what it means is that the 5-year Treasury note price is at an historic, all time high. For those readers unfamiliar with Treasuries, when the yield is low, the price is high.

The US Treasury sells these securities at or very close to par - that is, for 100 cents on the dollar. For the sake of this example, let's assume they're selling at par.

Yesterday, new 5-year Treasuries only yielded 1.26%. Treasury notes sell in increments of $100. So if you bought one of these Treasuries yesterday, on September 28, 2015, you'll get your $100, plus an additional $1.26 every year. In other words, you have to spend $100 to get $106.30 five years from now.

Never before have five 5-Treasury bonds cost so much, and yielded so little.

Compare that yield to what you would have received ten years ago, during the September 28th bond auction in the year 2000. Back then, five year Treasuries yielded 5.9%. So, you would have paid $100 to get $129.50 in five years.

You'll notice that the interest on these securities is not compounded; you get the same rate every year relative to the par price.

I've argued before that Treasury bonds, notes and bills are all in a huge bubble. Some people claim that Treasuries can't be in a bubble, because when you buy a Treasury, you're guaranteed to receive your principal investment back.

This argument completely discounts the likelihood of even modest inflation nibbling away at your principal. After all, I don't think there are many people that would expect inflation to stay less than 1.26% over the next five years. In the event of double digit inflation per annum on average (like we experienced in the late 1970s) this five year bond could lose nearly 40% of its value.

That looks suspiciously like a bubble brewing to me. And the worse the inflation, the bigger the losses on this Treasury note. Yeah, you'd get your principal back, but it would be worth much less than it was worth five years prior.

So how did Treasuries get so expensive, and the yield so low? The answer is demand. With high levels of uncertainty and fear in this tumultuous stock market (as well as in currency markets and muni-bond markets), bank failures and slowed growth in the United States, institutional and individual investors alike are seeking safety and security. In this environment paying $100 to get $6 five years from now sounds like a decent plan - especially since the loan is guaranteed by the Government.

As far as I'm concerned, the words "guaranteed by the Government" should raise red flags, not soothe investor nerves.

For the next five years, I'd rather have money in gold than Treasuries. How about you?

Disclosure: No positions