The Global Bull Bets Against the Bubble in U.S. Bonds

Nicholas Vardy

Nicholas Vardy has a unique background that has proven his knack for making money in different markets around the world.

Savvy investors know that anytime there are extremes in financial markets, there are also opportunities to profit. And this week’s Global Bull Market Alert pick — the Rydex Inverse Government Long Bond Strategy Inverse (RYJUX) — is the best way to profit from the coming collapse in U.S. government bonds.

Here’s why I think this trade has the potential to become the biggest trade of the year.

First, U.S. Treasuries are under increasing pressure from both the supply and demand side. On the supply side, the almost $1 trillion economic stimulus package contemplated by the U.S. government means that it will have to go hat in hand to the rest of the world even more than usual. Goldman Sachs estimates that the U.S. Treasury will have to raise more than $2.5 trillion in 2009 alone. That’s more than $1.6 trillion more than the U.S. Treasury raised in all of 2008. That’s an unprecedented level of supply coming on the market. It also means that the U.S. government will have to pay more and more interest on U.S. Treasuries to attract investors, pushing prices down, and the yields demanded by investors up.

Second, the demand side of the equation looks scarcely better. Consider the case of China. As a result of the economic slowdown, U.S. consumers are buying a whole lot fewer things that say “Made in China.” That means a lot less business for China’s manufacturing sector. That means less tax revenue for the Chinese government. Less tax revenue leads to a lower budget surplus and a lower trade surplus with the United States. The result? You can expect that the amount of excess U.S. dollars that are funneled back from China into the Treasury market is set to decrease substantially.

Third, there is the issue of coming inflation. Milton Friedman observed that “inflation is always and everywhere a monetary phenomenon.” Recent growth of the money supply suggests that it is only a matter of time until inflation will start to kick in. Consider that between September and December of 2008 the monetary base expanded from $905 billion to $1.65 trillion. Throw in the fact that the U.S. government’s debt burden — thanks to a combination of massive fiscal stimulus package promised by the Obama administration, increased social spending, and the costs of the wars in Iraq and Afghanistan — may reach levels that may not be possible to finance in a non-inflationary way. It is more bad news for U.S. Treasuries.

Finally, to add insult to injury, even good news is bad news for U.S. Treasuries. After the extreme rise in risk aversion during the October collapse, the frenzied safe haven buying of U.S. treasuries has come to an end. Let’s say that central banks throwing everything and the kitchen sink at the credit crisis starts to work. Any relief in global financial markets will mean that money will come out of U.S. Treasuries and go somewhere else. This scenario is also bearish for bonds, and good news for RYJUX.

The collapse of U.S. Treasuries is a question of not “if” but “when.” So buy the Rydex Inverse Government Long Bond Strategy Inverse (RYJUX) at market today and place a trailing stop of 10%.

Portfolio Update

The PowerShares DB Commodity Double Short ETN (DEE) hit a record high of $87.38 last week. This position continues to have a key role in the portfolio as a hedge against market downturns.

Market Vectors Double Short Euro ETN (DRR) slumped about 2% this week. This does not change my long-term bearish outlook for the euro.

iShares MSCI Emerging Markets Index (EEM) had a very strong week, soaring almost 12%. Emerging markets have outperformed U.S markets by more than 10% over the last three months — and are now in positive territory over that period.

Your short position in the CurrencyShares British Pound Sterling Trust (FXB) did poorly this week, as the British pound bounced sharply after hitting 23-year lows just two weeks ago. This is a short-term counter trend rally and I continue to be bearish on the British pound sterling.

Your short position in the iShares MSCI United Kingdom Index (EWU) performed poorly as global stock markets rallied. I continue to be bearish on the United Kingdom — though this position will suffer if markets continue their rally.

The iShares iBoxx $ High Yield Corporate Bond (HYG) ended the week flat. This position, yielding a whopping 11.2%, will soar as long as we avoid a completely disastrous outcome in the high yield market.

Millicom International Cellular S.A. (MICC) ended the week up about 5%. With J.P. Morgan’s short-term price target of $52, this has plenty of room to rise on any sustained rally.

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Your Global Stock Investor portfolio had a strong week, with two of your positions, PowerShares DB Commodity Double Short ETN (DEE) and the UltraShort Lehman 20+ Treasury ProShares (TBT), hitting record highs of $86.82 and $48.12, respectively.


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