Friday, November 20, 2009

Short End of the Yield Curve - WARNING!!!

The "big boyz" are piling into the short end of the U.S. government debt curve. This is not a good sign. This means they are fleeing stocks and looking for "safety" (I use the word because it is what paperbugs think, not what I think). They have distributed their stocks to the public and are now going to let them fall.

Pictures speak louder than words. Starting with the 2 year U.S bond yield (2 year daily chart using a log scale because the moves have been insane):

Here's the yield on a 1 year U.S. Treasury note:

And finally, the 90 day T-Bill yield:

The bond market is screaming deflation. I know, I know many of the big boyz are simply front running the fed for risk-free profits, but this is a big move on the short end of the curve and I think it is meaningful. The last big spike of this size towards zero on the short end of the curve was in September of 2008. Need I say more? Most of the stock investing public doesn't pay any attention to the bond market, and that's just fine with Wall Street. Big money is not so quietly stampeding for the exits from the stock market and the public will be left holding the bag - again.

Now this is where my thesis will be tested. I believe Gold will hold up here on the next bear leg down and even move higher regardless. Yes, it may undergo a correction for any distance back towards $1000/oz. at any time, but I think $1000/oz. is the floor for the Gold price now and a dip back towards these levels would simply provide another buying opportunity. In a stock market panic, Gold stocks will get sold off. In a stock bear market, Gold stocks move to their own drummer, generally sustaining corrections during the steepest downward parts of bear legs in general stocks, then rising the rest of the time if Gold is doing well. I believe Gold will do well.

This thesis relates to Gold's role as money. It is no longer a national currency anywhere, but it is an international currency of last resort and there is less and less trust in paper promises from the spendthrift nations of the world (e.g., U.S., UK, and Japan in particular). I do not think the U.S. is in worse shape than the UK or Japan, we just stand to lose more as the country with the ability to print the world's reserve currency. I believe the international monetary system is continuing to break down and Gold is rising relative to all currencies for this reason. When the yield on U.S. short-term government debt is basically zero, people stampeding into the short end of our government debt curve obviously aren't looking for yield!

This is what Exter's liquidity pyramid is all about. Read about it here if you aren't familiar with it, as I believe it is an important concept regarding the flight to safety in an unsafe financial world. As I have come to realize during my manic swings between inflation and deflation (I started as an inflationist, became a deflationist, and now I'm not sure and not sure it matters to me as a Gold holder at this point of the longer economic cycle), the Dow to Gold ratio will likely provide me the best road map for when to sell my Gold and get back into stocks. Once this ratio gets below 2, I'll be getting ready to sell my Gold and buy a truck load of Gold stocks and then will finally make the switch back to paperbug maybe a year or two after that. This is my rough road map and I don't know exactly how long it will take to get to the 1-2 range in the Dow to Gold ratio.

I would be mighty nervous right now if I was a bull on the S&P 500 (I haven't been for 3 years, but anyhoo...). I would be mighty comfortable staying short the general stock market if I had a long-term time horizon. My main focus right now is on Gold and the Gold miners and looking for opportunities to go long. I may not be able to resist a few general stock short positions if the stock market starts to deteriorate here as anticipated. Santa Claus may not be bringing a rally in the stock market this year...

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