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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: Wyätt Gwyön who wrote (11251)	4/2/2004 10:51:11 PM
From: russwinter	Read Replies (3) \| Respond to of 110194

This inflation has two main components, the subsistence aspect such as food, energy, and one might even argue areas like medical, at least in part. I doubt there is too much price elasticity there? And there's the production or input aspect, the goods that go into about everything made. The two, not just one, makes it a very powerful inflationary force. Clearly income is diverted to pay for this, but recently the evidence is that it's just been borrowed, thus fueling more inflation. So my thesis is that it is likely to be fueled by additional credit for as long as interest rates are at negative real rates and "stupid" lenders () make this money available. There may come a point when perhaps suddenly (inflationary panic?)the credit and borrowing is choked off, and you may get some version of your deflationary scenario. I can tell you I will be watching for a significant credit choke off, but until then, it's horse (inflation) and buggy (panic and bust). Backwardization: True, in many commodities, and a good challenging question. Apparently the market just believes these are temporary shortages, but in the areas (metals, and to some extent energy) I know pretty well, and have familiarity with, there is little new production coming on stream. In fact some very low cost, newer potential mines on a cash cost basis such as Goro (nickel) and Meadowlark (gold) have been afflicted by the runaway input costs of steel, concrete, energy, etc. Ironic isn't it? So I have to attribute the backwardization to the persistent bearish psychology of the market toward commodities. It was that way in oil and nat gas two years ago, and you would have cleaned up buying the long dated futures, and then again last year, and again this year. The market has been continually wrong about it's backwardization. I also don't really think they are looking at a Train Wreck along the same lines I am, so that wouldn't really account for it. () See next post from Contrary Investor commentary on this.

To: Wyätt Gwyön who wrote (11251)	4/2/2004 10:54:23 PM
From: russwinter	Respond to of 110194

Today's Contrary Investor on bond market "players" answering some comment Jeremy Seigel made in WSJ about bond market vigilantes signalling benign inflation. There is another section that follows on the Japanese that mirrors my earlier remarks on their mercantilist impact. "We Don't Need No Stinkeen' Badges...It's our belief that the "bond market vigilantes" of yesterday that Siegel refers to are simply being outgunned in the current environment. They are simply no match for the modern day technological warfare of liquidity creation and its attendant price fallout on asset classes of all types. And like chief vigilante Bill Gross at Pimco seems to have accepted in his own personal account, when outgunned, it's often best to just get out of the way. It's our feeling that in today's world, the vigilantes of yesteryear have simply been replaced by the enormous fixed income carry trade players, the hedge community, the behemoth derivatives giants walking the face of the earth, and the foreign central banks intent on mercantilist driven currency manipulation activities. The bond vigilantes of today supposedly wearing the white hats are the minority relative to this greater majority of speculators whose investment intentions have very little to do with monitoring or pricing in the real or perceived rate of inflation stateside at any point in time. In good part courtesy of the Fed's accommodation, we presently find ourselves with one of the steepest yield curves on record anywhere over the past half century. As you can see below, an approximate 300 basis point spread between the 10 year Treasury yield and the Fed Funds rate is about as wide as it gets. And with the combined Greenspan and Bernanke guarantees of continued monetary accommodation patience, it has simply been a green light period for leveraged financial speculation. It just so happens that beneath Siegel's calm and tranquil Treasury market, a volcanic eruption of leverage has been occurring. Leverage that could ultimately be very destructive should interest rates turn up unexpectedly for any reason. Leverage that certainly is one potential catalyst for interest rate volatility of significant proportion at some point down the road. Let's have a quick look at the numbers. What you see below are the net borrowings of primary bond dealers in this country. We're talking a little over $750 billion in total borrowings at last count in early 2004. This is a doubling of system wide leverage in the dealer community alone since year end 2000. This is how the mega brokerage firms on the Street are earning such high profits these days. They are playing interest rate spreads with huge amounts of levered investments. Significantly leveraged hedge funds such as Goldman Sachs, that are basically masquerading as brokerage and investment banking firms, have incredible earnings and capital sensitivity to the bond world, or more correctly to interest rate movements. Firms such as Goldman are after one thing and one thing only, short term profits. Do you really think these folks care about forecasting inflation out further than a few days or weeks? These folks aren't vigilantes, they're highwaymen plain and simple. And these days, we can assure you that there are a lot of highwaymen traveling the back roads of the fixed income markets willing to pick off a vigilante for a few basis points. We have but one very humble question regarding what you see above. In all sincerity, how does the incredible leverage underpinning bond prices of the moment ultimately unwind without causing at least some type of price dislocation? Honestly, we just don't have an answer. And it's not like the Fed doesn't know this magnitude of leverage exists. They helped foster the darn situation in the first place. There is no question that part of the reason Siegel's longer dated Treasury bonds are behaving so well is due to the incredible presence of the carry trade community (borrowing short and lending long on a leveraged basis). This community is made up of the hedge, brokerage, banking, etc. players. There is a hell of a lot of company on the same side of the trade here. That we're sure the Fed knows. And it probably keeps them up at night in terms of wondering how they will ultimately approach raising short rates without sending all of these collective masters of the universe rushing for the leverage exit door in simultaneous fashion. As a matter of fact, we're wondering the same thing."