Wednesday, December 17, 2008

A Look at U.S. Bonds

With the Federal Reserve lowering its Fed funds rate to near-zero and speculators-- oops, I mean "investors"--fleeing commodities and stocks, bonds have skyrocketed. Is it a new long-term trend or yet another bubble?

Super-low Fed rates and a flight to safety (i.e. the market is still expecting the U.S. Treasury to repay its bonds and interest due) have pushed U.S. bonds to the stratosphere. Recall that bonds' yield and face value act as a teeter-totter; a drop in yields raises the face value, and a rise in yield pushes down face value.

I asked frequent contributor Harun I. for some charts and commentary on the 10-year bond. While these charts look to me very much like a round, fragile object floating a few feet above the ground--i.e. a bubble--as Harun takes pain to note, we have to respect any breakout.
As always, please read the HUGE GIANT BIG FAT DISCLAIMER below which states that nothing here should be mistaken for investment advice; this is a free site and you get what you pay for, (heh) i.e. my observations and opinions. Harun's opinions are his own and they too should not be mistaken for investment advice.

Here are Harun's notes on the charts:

Please go to to view the 3 charts:

"By examining the three charts, one must accept without equivocation that a valid breakout of a major multiyear formation has occurred at the primary level. Momentum and trend indicators are just beginning to register but this is typical in fast markets.

On the monthly chart, a push to the top of the SE channel may be at hand. The confluence of the upper channel line and the 100% extension makes this a likely target. But the measuring implications of the formation indicate much higher prices. Which will prevail? We will have to wait and see.

The weekly chart with COT (Commitment of Traders) data indicates that while price movement is explosive, the mechanisms that are needed for sustainable price advancement are lacking. Open interest has all but dried up. Relative to times past, Commercial and Large Traders are noncommittal. While I did not include a Volume indicator, 25-week average volume is hovering around 30% below 50-week average volume. In short, capital flows and trader participation do not support price acceleration.

With that said, one must never argue with price. Traders may wake up and get on board this rally.
US 10-year notes are outperforming gold but the disparity between nominal value and real value is still quite significant. (No chart)

Finally, the daily chart indicates a successful assault on the R1 monthly pivot point with the major histogram of MACD overbought and the minor histogram declining toward equilibrium indicating a loss of short-term acceleration. Volume has strengthened from a very weak reading to parity with average 50-day volume. Even at the short-term level volume has not confirmed this rally.

As I have stated, it is never prudent to argue with price. If on the trend, stay on the trend but be mindful of the quality of price movement. Large interests can push around thin markets and clearly this market is thin.

If you have been whipsawed, don’t feel bad, Jim Rogers was forced to cover his shorts in bonds last week. If he was forced to cover I suspect many others were as well, which helped fuel this rally.

Is this a bubble? Of course it is; by now this should not be news. The Bond/Gold ratio is proof enough of the degree of distortion in US Treasury markets.

Is this the final blow off? I do not know, it could be. The current run-up is undoubtedly irrational. The fundamentals in the American debt markets, private and public, are severely impaired. The belief is that the US government will print money until collapse rather than repudiate its debt. The fallacy of this is evident; collapse is repudiation.

Referring back to the monthly (primary level) chart, if price stalls at the upper channel line and falls through the lower trend line of the wedge then the formation will have failed and a rapid descent can be expected.

On the other hand, the normal cycle is for bonds to top, then stocks, then commodities. Conversely, bonds typically bottom first, then, stocks, then commodities (e.g., US Treasuries topped in 1998, equities topped in 2000, commodities topped in 2001). If this were to hold true, regardless of the why or how impossible one may think it, at some point a rally in stocks and commodities is inevitable.

As stated earlier, the quality of the rally in the 10-year note is dubious. Traders in all classes are non-committal and volume on a relative basis does not confirm. That these divergences are occurring at all levels of trend should indicate caution.

January may prove pivotal as we go into the New Year overbought. This year, price could not close solidly below the January low, and a major rally is underway now that the January high has been solidly penetrated."

Thank you, Harun, for the knowledgeable commentary. In a side note, I want to note that the (Bear-Market) stock market rally that I anticipated in my December 1 entry appears to be underway.

Thank you, readers for the many excellent comments. With holiday-related work in full swing, I am hoping to post your comments tomorrow. Thank you for your patience.

Thank you, Robert D. ($25) for your most generous donation to this site. I am greatly honored by your support and readership.

Thank you, Gavin G. ($100) for your mind-bogglingly generous donation to this site. I am greatly honored by your support and readership.

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