Time to Short Treasuries Yet?

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Includes: IEF, TBT
by: Adam Sharp

By Adam Sharp

Every Ponzi Fails in Time

In February Nassim Taleb remarked that, "every single human being" should short US Treasuries. Mr. Black Swan may have been a little early, but he's right, of course. Treasuries are a bubble of epic proportions. And when that bubble pops, a lot of money will be made on the short side. For retail investors, that means using ETFs like TBT, which shorts long-dated treasuries (with leverage).

But getting the timing right on this trade has proven tricky. Bond prices just keep going up, pushing yields to absurdly low levels. Investors who bought ProShares UltraShort 20+ Year Treasury ETF (NYSEARCA:TBT) back in February, when Mr. Taleb made his "every single human" remarks, are down about 20% on their investment. Yield on 10-year treasuries has fallen to 2.8%. In April, the same bond was yielding 4%. In 2000, before the tech bubble burst, the 10-year was paying a healthy 6.7%.

With inflation expectations rising — and the dollar falling — why on earth would anyone loan the US money for ten years at 2.8%? They wouldn't. The only thing driving demand for treasuries is the Fed. And chinks are starting to show in their armor.

How Long Can the Ponzi Last?

I don't expect that Chairman Bernanke cared much for the world's reaction to QE2. If you need a refresher on the anti-QE case, this should help:

And every investor should read this commentary by Bill Gross. Here are some of the more interesting parts:

Check writing in the trillions is not a bondholder’s friend; it is in fact inflationary, and, if truth be told, somewhat of a Ponzi scheme.

The Fed’s announcement will likely signify the end of a great 30-year bull market in bonds and the necessity for bond managers and, yes, equity managers to adjust to a new environment.

The Fed wants to buy, so come on, Ben Bernanke, show us your best and perhaps last moves on Wednesday next.

Pay attention to that last line (hence the subtle bolding). Gross is hinting at something big when he describes QE2 as possibly being Bernanke's "last move." When Mr. Gross speaks, investors listen. He manages over a trillion — that's a t, not a b — dollars as head of Pimco, the world's largest bond fund.

In short, the man moves markets. So the fact that he is blatantly calling the US economy a Ponzi scheme does not bode well. Gross has dubbed the system a "Sammy Scheme," with our own Uncle Sam reprising the role of Charles Ponzi.

QE2: Fed Curtain Call?

QE2 should succeed in temporarily pushing yields down further, but it's not guaranteed by any means. Bond holders may well see this as the perfect opportunity to sell their bonds to the Fed at a healthy premium. For managers looking to unload large quantities of bonds, it's a windfall opportunity. Over the next eight months, they know Bernanke will be "on the bid" almost every day, gobbling up $900b worth of treasuries. But after QE2 ends, all bets are off. This could be the last good chance for money managers and central bankers to dump their treasuries.

Don't get me wrong; QE3, 4, 5, 6, and beyond are certainly possible. If Bernanke and the doves get their way, the printing won't end any time soon. But if inflation starts to look worrying, or the political situation changes, the printing presses could come to a screeching halt. If that happens, bond shorts stand to make a killing...

Verdict

It's time to test the waters. Last week, I opened a small position in TBT, a double-short treasury ETF. I'm just dipping my toes in at this point, and will watch closely for changes to the situation.

Why go short with the Fed buying? It certainly violates the investing maxim Don't Fight the Fed...

I'm aware of the risks, and am starting the position because I suspect that when the snowball starts rolling, the move will get quick and violent. As a bonus, funds like TBT act as natural hedges to gold, as shown in the chart below (gold in blue, TBT in red).

So those with large precious metals positions may get some downside protection in their portfolio by shorting treasuries.

gold-vs-treasury-shortClick to enlarge

(Click to enlarge)

In a world where attractive investment options are lacking, shorting treasuries is looking better by the day.

Disclosure: Author short TBT