Italy Is The Latest Country To Be Hit By The Bond Vigilantes

Includes: DDR, EUO, GLD, UGL
by: Robert Hallberg

The precarious situation in Europe is quickly spiraling out of control and Italy is the latest country to be hit by the bond vigilantes. The yield of its 10 year notes has quickly jumped from 4% to over 7% and they will soon find themselves in a position where they are unable to pay interest of their debt.

Before the crisis unfolded in Greece they had a debt to GDP ratio of 115% and a bond yield (10 year notes) of roughly 5%, and despite cuts and austerity, debt to GDP went up to 150% and bond yields soared to over 28%. Italy today has a debt to GDP ratio of 120% and they are finding themselves in Greece situation a year ago. The only difference is that Italy is a much bigger country and it is unlikely that the northern states will be able to bail them out.

The chart shows the yield of Italian and Greek 10 year bond notes. If the yield of Italian bonds continues to rise they will soon find themselves unable to obtain financing.

Greece Bonds
(Click to enlarge)

Italian government bonds

Italy - Bonds
(Click to enlarge)

The whole idea of the euro was a bad idea from the very beginning. The notion that you could cobble together a currency from countries with vastly different economies and with no backing whatsoever has proved to be a daunting task.

The future for the euro is bleak with no improvements in sight. Italy, Portugal, Greece, Ireland and Spain are all in the same boat and perhaps France will be the next country to follow. With so many problems in the eurozone, many are asking if the euro will even exist a year from now.

The first things that comes to my mind is to short the euro. However, the problem with this approach is that you must go long another broken fiat currency, like the dollar, that is continuously being debased. A better approach might be to buy gold priced in euros. However, this may be difficult more someone outside the eurozone. You would first have to convert your dollars into euros and then use them to purchase gold.

As an alternative you can create a synthetic spread position by using an etf that is shorting the euro, such as ProShares Ultra Short Euro (EUO) or Market Vectors Double Short Euro (DRR) and going long SPDR Gold Trust (GLD) or ProShares Ultra Gold (UGL), to match up the double short position in the euro with a double long position in gold.

Because this is a speculation and we are using leveraged instruments I don’t recommend putting more than 3-5% of your portfolio into this trade. The situation in Europe is precarious and no one knows how long it will hold together but leveraged instruments can quickly drain your capital if the trade does not work out.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.