"Operation Twist" announced
Yields on 30 year Treasury bonds dropped below 3% for the first time since 2009 on Wednesday, after the Federal Open Market Committee announced it would swap $400 billion of debt maturing in 3 years or less for Treasury securities maturing in 6 to 30 years. Gold fell on the day, with spot prices trading below $1,789 per ounce on Wednesday afternoon.
Inflation versus deflation
As Martin Wolf noted in his Financial Times column last month,
Those who fear deflation buy bonds; those who fear inflation buy gold; those who cannot decide buy both.
Judging by Wednesday's market action, deflation seems to be the greater fear for investors at the moment. Gold and Treasury investors who aren't certain whether inflation or deflation is more likely going forward may want to consider hedging their positions.
Hedging Treasury and gold ETFs
The table below shows the costs, as of Wednesday's close, of hedging 3 gold ETFs and 5 Treasury ETFs (3 of them levered), tracking Treasury securities with maturities from 7 to 20+ years. First, a reminder about what optimal puts mean in this context, and why I've used 20% as a decline threshold here; then, a screen capture showing the optimal puts for one of the Treasury ETFs listed below, the iShares Barclays 7-10 Year Treasury Bond ETF (IEF).
About Optimal Puts
Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. Portfolio Armor uses an algorithm developed by a finance Ph.D. to sort through and analyze all of the available puts for your position, scanning for the optimal ones.
You can enter any percentage you like for a threshold when using Portfolio Armor (the higher the percentage though, the greater the chance you will find optimal puts for your position). I have used 20% thresholds in each of the examples below. Essentially, 20% is a large enough threshold that it reduces the cost of hedging, but not so large that it precludes a recovery.
The Optimal Puts for IEF
Below is a screen shot showing the optimal puts for one of the Treasury ETFs listed below, the iShares Barclays 7-10 Year Treasury Bond ETF (IEF). This shows the optimal put option contracts to buy to hedge 100 shares of IEF against a greater-than-20% drop between now and March, 16, 2012.
One note about the cost of these optimal puts: to be conservative, Portfolio Armor calculated the cost based on their ask price. In practice, an investor can often purchase puts for a lower price, i.e., some price between the bid and the ask.
Hedging costs as of Wednesday's close
The hedging costs for the gold and Treasury ETFs below are as of Wednesday's close.
Cost of Protection (as % of position value)
|US Treasury ETFs|
Direxion Daily 20yr+ Trsy Bull 3x
|UBT||ProShrs Ultra 20yr+ Trsy (2x)||6.81%***|
|TLT||iShares Barclays 20yr+ Trsy||1.11%**|
|TYD||Direxion Daily 10 Yr Trsy Bull 3X||1.73%*|
|IEF||iShares Barclays 7-10 yr Trsy||0.24%**|
|GLD||SPDR Gold Trust||1.42%**|
|DGL||PowerShares DB Gold||9.61%***|
|IAU||iShares Gold Trust||3.16%***|
*Based on optimal puts expiring in February, 2012
**Based on optimal puts expiring in March, 2012.
***Based on optimal puts expiring in April, 2012