My apologies for the long hiatus, but I had a very good reason for my absence (and no, it involved neither jail time nor time hiking in Iran). Though all markets---equities, bonds, commodities---have been quite crazy over this past year, in many respects I don't feel like I've missed much in reporting: after all, it is the same 3-year old story (dating back to 2008 now) of heretofore unprecedented volatility and constant rushes to or from "risk on" to or from "safe-heaven." Its like watching looters empty a burning building: as the flames intensify, the looters frenzy even more frantically to take whatever is left before it is too late. People are risking everything for such little gain.
Case in point, the perennially perplexing (to me, anyway) Treasury rally! Last week, the 2-year Treasury hit another all-time record low yield, paying just 0.1451%. Think about that for a minute: this incredibly low yield means that institutions are willing to give the US government, for example, a 2-year $1,000,000 loan in exchange for measly $1,451 total profit (assuming that in two years they even get the principle back!). And, that assumes no CDS coverage: if the CDS rate on 2-yr's is just a ten basis points (and I do not know what it is currently), that profit is reduced to $451. This, mind you, is considered a "rush to safety"---risking a million for less than a grand's total maximum profit!
But, many institutional investors don't hold US paper (even short 2-yr paper) to maturity: instead, they sell it again on the secondary market. If rates do not decrease within the next two years, these investors lose money: they will not be able to sell the paper for more than they paid. Massive amounts of capital from all over the globe are going into Treasuries right now as Treasuries are at record high prices. Much of this capital is bank balance sheet capital, including a rush out of euro over to USD (via the Fed's never-ending eurodollar scheme) by the European banks. What happens to the value of these massive UST holdings on bank balance sheets when UST comes off the highs?
Seriously---how much lower can the 2-yr go than 0.1451%?
Well, it can go 0.1451% lower!
In other words, the highest possible gain for these investors in UST is par value, and they are only 0.1451% below par value when they buy! But the total possible losses are full par value negative, as they could get nothing back if the US defaults in two years (*more on this later). At least when you buy a stock at an all time high, there is the chance it can go higher, and higher, and higher---theoretically, indefinitely. But bonds are the opposite: par value is a value cap. Who is going to buy dollar in the form of UST at more than face value when anyone can always buy dollars themselves at face value---in the form of regular cash?! A cash note is UST at face value: why on Earth would an investor pay $1.01, or over par value, for 2-yr Treasury when he can get a mature $1 note (read: cash) for par value? In the latter case, of course, he's not making any money, but that still beats the first case, where he's guaranteed to lose money. Of course, we actually did see negative 3-week rates back in December 2008, and that was caused by the (justified) total lack of confidence in counterparties and cash "shortage"; banks were willing to take that 0.001% haircut if it came with that government guarantee. But guess what else they also took as par value collateral at that time? They took CASH.
And they took cash because the other "collateral" they had (RMBS, CMBS, generally BS paper!) was suddenly both compromised (due to the market collapse) and uninsured (but to the counterparty/AIG collapse). Basically, what we saw here in the US from around August 2008 to January 2009 is what Europe is seeing right now. However, there are some significant differences, as well, perhaps the most important of which is the difference in nature of the euro versus that of the dollar.
As per my title, the national and "global" (read: European) economies are in even worse shape than they were at the time of last post in November 2010, and I will prove it (as if you need me to)---but later tonight with another post, currently titled Cage Fight Announced: USD/EUR v. Au/Ag, Round 1! This is an exciting time for the hard money crew: it doesn't get better than this!
I'm glad to be back, and check in later... :)