Preparing For The Burst Of The Treasury And Precious Metals Bubbles

by: BubbleBustInvesting

US Treasuries and precious metals usually trade in the opposite directions. US Treasuries are good bets for a weak or even depressed economy accompanied by low inflation or deflation. Precious metals are good bets for a strong economy accompanied by high inflation rates.

In recent years, thanks to an ultra-low interest rate policy by central bankers, this relationship has been broken. Money has been flowing on both assets, chasing their prices to the moon. The ten-year US Treasury has been trading at a yield south of 2 percent, while gold has been racing towards the $2,000-per-ounce mark.

Last week, investors in these two asset classes got a bitter taste of a reversal in these two trends. In just a few days, the ten-year bond-yield spiked to 2.30 percent, while gold dropped in triple digits. Is this the beginning of the burst of the two bubbles?

It is hard to say. What we can say, however, is that a burst in the two bubbles will be caused by a spike in interest rates that will cause a big correction beyond bonds and precious metals, causing a reversal to a number of popular trades.

Here are some trades investors may want to consider in order to prepare for this prospect:

1. Stay away from U.S. Treasuries and Treasury ETFs like TLT. Aggressive investors may want to consider establishing short positions by buying ETFs that are short on Treasuries like TBT and PST.

2. Stay away from Precious Metals and Materials. A spike in interest rates will be followed by a sharp rise in the dollar, which is negative for both precious metals and materials producers, especially those that are heavy exporters, e.g., Walter Energy (NYSE:WLT) and Freeport-McMoRan Copper and Gold (NYSE:FCX). Investors may want to trim their positions in iShares silver trust (NYSEARCA:SLV), and in SPDR Gold Shares (NYSEARCA:GLD).

3. Stay Away from Momentum Stocks. Momentum investing is a strategy based on hype about an investment theme, a new product or a new industry that captures and captivates the investor mind-- at times when money is cheap. In the late 1990s, the theme was telecommunications and networking, with momentum funds flowing into companies like Ciena Corp (NYSE:CIEN), JDS Uniphase Corp (JDSU), Corning, Inc. and Ariba Inc. (NASDAQ:ARBA). Now the theme is social media and web-based companies, like Open Table Inc. (NASDAQ:OPEN), and Zynga (NASDAQ:ZNGA). Momentum investing can be very rewarding as long as it lasts. But it can result in hefty losses once it fades away, especially for investors who got in at the top.

4. Stay away from High-Dividend-Paying Stocks - stocks that fare better during a low interest environment, like utilities ETFs like XLU and individual utility companies like Duke Energy (NYSE:DUK) that had a big run up in recent years, and tobacco companies like Altria Group (NYSE:MO).

Disclosure: I am short GLD, SLV, TBT, and XLU.