Are bonds once again 'certificates of confiscation'?advertisementWith yields so low, fixed-income investments offer little except the chance to give money away. Meanwhile, the correction in gold offers a chance to benefit from a bounceback.
By Bill Fleckenstein
Given the many questions about the fixed-income market that I have recently received from readers of my daily column, I thought Chronicles readers might be in the mood to review the topic this week. I'll also take a look at the whitewater buffeting the metals and foreign currencies, with some thoughts on how to mine this correction for opportunities.
0% puts kibosh on bonds
In some ways, the fixed-income market is almost rigged. It has been held at what would seem an absurdly low level of yield predominantly for two reasons: First, the functional equivalent of 0% Fed funds and the "promise" that rates won't rise without advance warning have created a gargantuan amount of participation by large speculators, banks, and finance companies in the carry trade, i.e., borrowing short and lending long in a highly leveraged manner. This activity has extended into the mortgage market, most likely the corporate market and perhaps even the junk market. Second, the fixed-income market has seen a huge bid by Asian banks, notably in Japan and China, that are trying to peg the dollar.Your money, fast.
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The action of the fixed-income market does in fact expose one urban legend, that being the concept of "bond vigilantes." For folks not around in the 1980s, the term was coined to describe bond buyers so fearful of inflation/inflationary developments that at the very hint of such, they'd tank the bond market and raise yields, thereby nipping inflation in the bud.
A taste for the curvaceous
For the most part, this has always struck me as a ridiculous notion. By my reckoning, what bond guys like more than tight monetary and fiscal policy is a steep yield curve and gobs of liquidity. After all, our currency's epic decline, two years and running, has also seen oil reach $35 a barrel and GDP clock in at a supposed 8% for the recent third quarter -- while fixed income was hardly dented. At about 4.9%, 30-year Treasury yields are within 10 basis points of what they were on Sept. 30, 2003. I don't know what further proof is needed.
I guess one could take the view that the bond market is seeing through the aberration of third-quarter strength and spying a collapse in the price of oil, etc. That perspective, however, seems a bit of a stretch, despite my belief that the economy is in the process of weakening. For all the above reasons, I have a hard time getting excited about fixed income. If the economy somehow miraculously catches fire, bonds would once again become -- as they were called in the early 1980s -- "certificates of confiscation."
As for why the dollar's decline has hardly mattered to fixed income, I think the reasons are twofold:
* The Chinese and Japanese have continued their purchases, no matter what happens to the dollar.
* At the margin, domestic buyers don't believe a declining dollar will hurt them. In my opinion, that seems like a rather insular view.
Dollar apathy from Easy Al -- until there’s a problem
If my view of the economy and stock market turns out to be correct, I believe that, at some point, we are likely to see an unambiguous panic in the currency market. I have long felt that Alan Greenspan didn't give a damn about the dollar. And he would exclude the impact of its decline from policymaking decisions until an absolute crisis dragged him kicking and screaming into action.
I actually had that view confirmed last week in a roundabout way. I count as a friend a very sophisticated fixed-income participant who ranks near the top of one of the most successful macro hedge funds on the planet. He passed along to me a quote relayed to him, reportedly straight from the Federal Reserve chairman's mouth, that the chairman didn't care about the dollar. Take that hearsay at face value, but it's certainly corroborated by all the actions and speeches of Easy Al and the rest of the Fed heads.
Fixed-income investments: the least of 3 evils
Meanwhile, though I can't get excited about the fixed-income market, for folks who can't hold cash it seems the lesser of evils when compared with stocks and real estate. (I prefer the higher-yielding debt of foreign governments such as Australia and Canada. However, though one gains exposure to the upside potential of currency appreciation, there is the obvious exposure to the downside as well.)
I would keep my maturities on the shorter side, certainly less than three to five years. I am not particularly enamored of TIPS (Treasury inflation-protected securities) because I don't like the fact that the government gets to calculate what the rate of inflation is. In my dream buying scenario, TIPS would offer mouth-watering yields, because folks would be concerned not just about inflation but how inflation is calculated. That would give folks a fair spread over the true rate of inflation, as compared to what the government claims.
So, what’s with the metals?
Now, for folks whose disaffection with the Fed has steered them to the metals and currencies, here are my views on the recent rough sledding in these markets. As readers of my daily column know, due to my concern and expectation of a major violent correction, I had been trying to sort out the year-end and new-year flow of funds, and have been unusually focused on short-term machinations.
That correction in the metals is upon us. Gold fell more than $13 Thursday to $408.70 an ounce. I don't know how long the correction will last or how deep it will go. What I can say is that the prior corrections we have seen have been short in time and deep in price, as is characteristic of all bull-market pullbacks. I don't expect that gold will spend much time below $400, plus or minus. Whether that means $395 or $405, I have no idea. But, at roughly those prices, I believe there will be many producer buybacks and a bit of a floor under the commodity. Further, we still have the nearly all-but-forgotten exchange-traded fund for gold in front of us. This current correction is going to be the one that folks will really want to nail. Regrettably, the length of its run in price and time is not knowable in advance.
Segueing to the currencies, most everything I've said about the metals reflects my views on the currencies. I have been hoping for a big setback in the currencies that would a) enable me to rebuild my currency position and b) perhaps afford a reduced-risk entry point for buying foreign bonds. Meanwhile, I think that the metals/currencies correction will provide us with a buying opportunity, though, to repeat, I don't know the pacing. I am watching intently for clues, and I will keep readers informed as best I can. |
