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I decided to write this article because some analysts still do not understand how the Federal Reserve System and the bond market work. One reason why the bond market is going up is because the Fed has said repeatedly that they will do anything necessary (perhaps this includes throwing money from a helicopter?) to avoid deflation in United States and around the world.

For this reason the market sees how the Fed would support the Treasury Bonds. The same seems to be happening with the European Central Bank and Germany saving every country in trouble. Well, apparently not many see the problem they are causing: This is a Debt Time Bomb because every year the portion to pay interests on the debt will be bigger, until the music stops.

It seems that these analysts do not know the monetary system and IGNORE that gold is trading today at about $1620 per ounce, which is an indicator of government mismanagement.

It is impossible to print money out of thin air with no tangible wealth to support it. It doesn't work. If that were the case Zimbabwe with President Mugabe would be the most prosperous nation on the planet, perhaps it is the mentor of many of today's central bankers.

I understand the Federal Reserve's decision to provide stimulus through QE1,QE2, QEn... as it is the only practical option politically speaking at this stage of the game. It is our task to analyze and predict events in order to accommodate our capital in the most appropriate sectors.

In the long term, bond prices have nowhere else to go but down. You buy bonds when yields are high and as the yield decreases, the bond price rises towards maturity. The opposite happens when you buy a bond with a low yield with rising interest, meaning the bond loses value.

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The time to buy bonds was in the early 80s when Paul Volcker raised interest rates in the U.S. to neutralize the rampant inflation that had been happening in the system; this exaggerated rise in interest rates is what brought the big capital flow into the U.S and its debt, back then paying about 20% interest the 10yr Bond, much more in the 30 year Bond.

This was like a drug for the U.S. to see how it could increase its debt while enjoying a privilege: be the issuer of the World Reserve Currency. Since then the US has built up an extraordinary level of debt and set the start of decades of rampant credit expansion.

Finally, I want to leave you with a graph of the ratio between Treasury Bonds and gold; the higher the number means that gold is outperforming bonds and the lower, bonds outperforming gold.

Long Gold

if you want to go long gold using the GLD ETF, use it just for trading. We prefer to buy bullion to keep it for the long run.

Short Bonds

A long term play can be good to short bonds with the Powershares Ultra-short 20+ Treasury Bond (TBT). ProShares Short 20+ Year Treasury ETF (TBF). These are all opposites of iShares Barclays 20yr Treasury Bonds ETF (TLT) and the iPath US Treasury Long Bond (DLBL) both are long play in bonds.

(click to enlarge)

There is a clear trend since the beginning of 2001. We follow the course with our positions in gold and silver bullion and mining shares. Nothing has been resolved, rather, it seems to have added fuel to the fire and set the stage for the big rise in the gold price.

The market will pick a clear winner again. You can play it short with TBL Ultra-Short.

Please share this article if you find it useful for investors.

Source: The U.S. Treasury Bonds Illusion

Additional disclosure: I have positions in gold and silver bullion.