Bears’ Next Target: Bubble In US Treasuries

Yes. Here’s why:

1. The bailout money is not being lent to consumers, but is being used to buy Treasury bonds.

2. We’ve been Treasury bond prices rise strongly (i.e. falling yield rates), which reflects increased demand for Treasuries. At the same time, though, the fundamentals of the US dollar (the underlying asset the Treasury bond is a derivative of) are deteriorating: the country is carrying more debt while taxes are declining and government spending is increasing.

3. Consistent with Austrian business cycle theory, bubbles are the result of central bank distortions in the money supply. Peter Schiff recently wrote an excellent article elaborating on this topic.

As we’ve seen, bubbles don’t last forever — and they always search for needles. So the question: how will the Treasury bond bubble find its pin, and what happens when it does?

1. According to Ka-Poom Theory, a black swan event — an outlier with a disproportional impact — will be the trigger to causing the Treasury bubble to quickly pop. In recent US history, previous examples of black swan events that have lead to sharp bubble deflations have been (1) 9/11 popping (the dot com bubble and (2) Bear Stearns collapse bringing about the subprime crisis and the collapse of the mortgage bubble.

2. As Treasury bonds are owned primarily by foreign countries, the popping of the bubble will be external to the US economy. In other words, deflating of Treasuries requires debt holders in foreign nations, particularly China and Japan, to sell off.

3. Just as global deleveraging to pay off dollar denominated debts resulted in a sale of foreign currencies to purchase the US dollar, a mass exodus of Treasuries led by foreign holders will result in Treasury bonds being sold and exchanged for foreign currencies. And given that China and Japan are primary Treasury bond holders, an appreciation in those currencies as that money is brought home seems natural.

So when will it happen?

Impossible to predict, in my opinion. As a market bear by nature, I think playing this from the short side by looking for when momentum in the Treasury bond market turns south represents an opportunity. Currently, the chart for TLT (TLT), a 20+ year Treasury bond ETF, looks a bit bullish. and is rallying after bouncing off support in the 111.60 area. Should the market re-test this level with bearish momentum, it may be an opportunity ride a bear trend as the Treasury bond bubble begins to deflate.

Below is the chart for TLT.

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