U.S. Treasuries, like the iShares Barclays 20+ Year Treasury Bond ETF (NYSEARCA:TLT) are said to be a bad investment due to huge government debt. That's all talk, but I can actually prove that in the short-term, U.S. Treasury yields are overbought and could underperform. For this, first I will be using the theory of quantity of money. And secondly, I will be using the indicator of Money with Zero Maturity velocity.
- Theory of Quantity of Money
When we talk about money supply, we use the theory of quantity of money, which is expressed in this formula:
M x V = P x Q.
Money Supply times Velocity of Money = Price Level times Quantity of Real Output
Money Supply M has been growing like crazy because of the Federal Reserve. See Chart 1. M2: 40% rise since 2007.
Click on charts below to enlarge:
But Velocity of Money V has been going down. See Chart 2. M2 Velocity 18% decline in value since 2007.
Which means that price level P hasn't been going up as fast as we thought. Because the money velocity went down. People didn't spend much; economic activity has gone down since the economic crisis of 2008.
Still, if we net it out, we still have a rise in nominal value (P.Q) of output (we assume that output hasn't increased much). Which means we should have a price level increase. And that can be seen in the rise in oil prices, gold price rising, etc... A price level increase basically means inflation, and that's bad for U.S. Treasuries in general.
This is evidence number 1.
- MZM velocity
Money with Zero Maturity is defined as a measurement of the supply of financial assets redeemable at par on demand. MZM velocity correlates very well with 10 Year US Treasury Yields.
Let's look at the 10 year U.S. government bonds (Chart 3: green). The 10 year yield went down from 4.6% (2007) to 2% (2012). This is more than a 50% decline.
MZM velocity went down from 1.9 to 1.45, which is only a 25% decline.
So this tells me that 10 year U.S. bond yields went down more than the velocity of MZM or the velocity of MZM has more downside to it. So either yields will start moving up, or the velocity of MZM will start going down (economic slowdown)
To make it more clearer, I'll add the Charts 3 and 4 together. So we get Chart 5 (orange = velocity, blue = 10 yr yield):
And viewed as a percentage change, we get Chart 6 (orange = velocity, blue = 10 yr yield):
As you can see on Chart 6, the correlation is clear. But recently, in the second half of 2011, we saw that the 10 year yield has gone much lower than the velocity of MZM. Which indicates to me that U.S. government bonds are overbought. And so we have evidence no. 2.
Conclusion: I don't recommend to hold U.S. Treasuries at this point.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.