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I was as stunned as anyone when the yield on the ten year Treasury bond (TLT), (TBT) plummeted to 1.42% two weeks ago. Predictions that long dated government paper would reach subterranean Japanese levels, considered loony as recently as a few months ago, are now donning the mantle of respectability, and even plausibility. Where will this end? With yields at 1.25%, 1%? 0.50%?
As with any ground breaking, epoch making, even cataclysmic change in the fundamental structure in the global financial markets, I searched for the reasons why I didn?t see this coming. How could I be so wrong? What did I miss? I haven?t been this far off base since the term ?blue dress? entered the political lexicon.
Then I looked at the recent ownership of the Treasury bond market and the answer was so obvious that it practically lifted me up by the lapels of my Brioni jacket and shook me until the gold inlays fell out of my teeth. The implications for international finance are huge, and are even bigger for your own net worth.
It turns out that governments have been steadily taking over the global bond market, not just Uncle Sam, but all major countries that have been pursuing quantitative easing. As a result, private ownership of Treasury bonds has shrunk from 55% thirty years ago, to only 23% today. Foreign holders, primarily central banks, have increased their portfolios from 13% to 34% during the same period. The Federal Reserve?s ownership of the Treasury market has soared from 5% to 11% since 2012, thanks to QE1, QE2, and the twist policy.
Therein lays the problem. Governments aren?t like you and I. They are the ultimate ?dumb money?. Once they buy a bond, they don?t care what the price is. They just carry it on their books at face value. They don?t need to mark to market. When debt matures, they just roll it over into similar issues. If you or I tried this, we would go to jail, and possibly even share the same cell.
The bottom line on all of this is that governments are uneconomic, irrational, and even price insensitive buyers. If the price goes up they don?t care. They also don?t do what the rest of us do when prices spike, as they have done, and that is sell. That?s because they don?t have clients like we do. This has created an unnatural market where the demand for government paper is nearly limitless, and the supply is inadequate.
Using this analysis, the big surprise is not that ten year yields hit 1.42%, but that they took so long to get there. This also suggests that bond interest rates will stay unbelievably low far longer than anyone realizes, possibly for years more.
There is another angle to this, which the pols on Capitol Hill failed to recognize. As a result of the new Dodd-Frank financial regulation bill, many derivatives contracts will become marginable for the first time. With the aggregate amount of such contracts estimated at $700 trillion, even just a minimal 1% collateral requirement would automatically create $7 trillion in potential Treasury paper buying.
That is little less than half the current $15 trillion national debt. In fact, it was massive government mandated bond buying in Japan just like this that kept interest rates so low there for so long. I know because I have written three books on this topic.
Much of the current political debate revolves around the belief that the US government is borrowing too much money. But the markets are screaming at us that the complete opposite is true. It is not borrowing enough. There is in fact a global savings glut and bond shortage that looks to get worse before it gets better. As for the monstrous, untamable inflation that such high levels of borrowing created in the past, like the Loch Ness Monster, the Yeti, and Bigfoot, and I?ll believe it when I see it.
Look, There Goes Inflation
With smoke still rising from the ruins of the recent silver crash, I thought I?d touch base with a wizened and grizzled old veteran who still remembered the last time a bubble popped for the white metal. That would be Mike Robertson, who runs Robertson Wealth Management, one of the largest and most successful registered investment advisors in the country (click here for his site at www.robertsonwealthmanagement.com).
Mike is the last surviving silver broker to the Hunt Brothers, who in 1979-80 were major players in the run up in the ?poor man?s gold? from $11 to a staggering $50 an ounce in a very short time. At the peak, their aggregate position was thought to exceed 100 million ounces.
Nelson Bunker Hunt and William Herbert Hunt were the sons of the legendary HL Hunt, one of the original East Texas wildcatters, and heirs to one of the largest Texas fortunes of the day. Shortly after president Richard Nixon took the US off the gold standard in 1971, the two brothers became deeply concerned about financial viability of the United States government. To protect their assets they began accumulating silver through coins, bars, the silver refiner, Asarco, and even tea sets, and when it opened, silver contracts on the futures markets.
The brother?s interest in silver was well known for years, and prices gradually rose. But when inflation soared into double digits, a giant spotlight was thrown upon them, and the race was on. Mike was then a junior broker at the Houston office of Bache & Co., in which the Hunts held a minority stake, and handled a large part of their business. The turnover in silver contracts exploded. Mike confessed to waking up some mornings, turning on the radio to hear silver limit up, and then not bothering to go to work because knew there would be no trades.
The price of silver ran up so high that it became a political problem. Several officials at the CFTC were rumored to be getting killed on their silver shorts. Eastman Kodak (EK), whose black and white film made them one of the largest silver consumers in the country, was thought to be borrowing silver from the Treasury to stay in business.
The Carter administration took a dim view of the Hunt Brothers? activities, especially considering their funding of the ultra-conservative John Birch Society. The Feds viewed it as an attempt to undermine the US government. The proverbial sushi hit the fan.
The CFTC raised margin rates to 100%. The Hunts were accused of market manipulation and ordered to unwind their position. They were subpoenaed by Congress to testify about their motives. After a decade of litigation, Bunker received a lifetime ban from the commodities markets, a $10 million fine, and was forced into a Chapter 11 bankruptcy.
Mike saw commissions worth $14 million in today?s money go unpaid. In the end he was only left with a Rolex watch, his broker?s license, and a silver Mercedes. He still ardently believes today that the Hunts got a raw deal, and that their only crime was to be right about the long term attractiveness of silver as an inflation hedge.
Nelson made one of the great asset allocation calls of all time and was punished severely for it. There never was any intention to manipulate markets. As far as he knew, the Hunts never paid more than the $20 handle for silver, and that all of the buying that took it up to $50 was nothing more than retail froth.
Through the lens of 20/20 hindsight, Mike views the entire experience as a morality tale, a warning of what happens when you step on the toes of the wrong people.
Silver is Still a Great Inflation Hedge
?For Europe to be competitive, to reflect the seizing up of the economy, you need a Euro that is at par or lower,? said John Brynjolfson, managing director of hedge fund Armored Wolf
?To get rich is glorious!? said Deng Xiaoping, the Chinese general who launched the country?s modern economy in the seventies.
I spent a sad and depressing, but highly instructional evening with Dr. Stephen Greenspan, who lost most of his personal fortune with Bernie Madoff. The University of Connecticut psychology professor poured the bulk of his savings into Sandra Mansky?s Tremont feeder fund; receiving convincing trade confirms and rock solid custody statements from the Bank of New York.
This is a particularly bitter pill for Dr. Greenspan to take, because he is an internationally known authority on Ponzi schemes, and published a book entitled Annals of Gullibility-Why We Get Duped and How to Avoid It. It is a veritable history of scams, starting with Eve?s subterfuge to get Adam to eat the apple, to the Trojan horse and the Pied Piper, up to more modern day cons in religion, politics, science, medicine, and yes, personal investments.
Madoff?s genius was that the returns he fabricated were small, averaging only 11% a year, making them more believable. In the 1920?s, the original Ponzi promised his Boston area Italian immigrant customers a 50% return every 45 days. My suspicious grandmother wisely passed on an invitation to join the plan.
Madoff also feigned exclusivity, often turning potential investors down, leading them to become even more desirous of joining his club. For a deeper look into Greenspan?s fascinating, but expensively learned observations and analysis, go to his website at www.stephen-greenspan.com .
Since I am an avid collector of investment scam stories, I?ve got to update you on what?s been coming out of Switzerland. Two Japanese nationals were caught smuggling $134 billion in US Treasury bonds from Switzerland to Italy in a false bottom suitcase. No, that is not a typo, that is ?b? for billion. The two were mysteriously let go the next day.
The blogosphere is exploding with conspiracy theories about the paper, which is almost certainly fake. Are there now so many T bonds out there that $139 billion of bogus ones can easily disappear into the mix? Personally, I see North Korea?s and the Japanese yakuza?s fingerprints all over this. Fake bonds can?t be traded, but I can think of any number of banks in Switzerland that would unwittingly accept them as collateral. But collateral for what?
Why do I expect George Clooney and Brad Pitt to pop up on this one. (Ed note: please see gratuitous attempt to include George Clooney?s photo in a financial newsletter for the female readers).
I had a chat with Bill Gates, Sr. last night, co-chairman of the Bill and Melinda Gates Foundation, the world?s largest private philanthropic organization. There, a staff of 800 help him manage $30 billion.
The foundation will give away $3.1 billion this year, a 10% increase over last year. Some $1.5 billion will go to emerging nation health care, and another $750 million to enhance American education. The foundation?s spending in Africa has been so massive, that it is starting to have a major impact on conditions, and is part of the bull case for investing there (please click here).
The fund happens to be one of the best managed institutions out there, having sold the bulk of its Microsoft (MSFT) stock just before the dotcom bust and moving the money into Treasuries. Mr. Gates? pet peeve is the precarious state of the US K-12 public education system, where teaching is not as good as it could be, expectations are low, and financial incentives and national standards are needed.
When asked about retirement, he says ?having a son with a billion dollars puts a whole new spin on things.?? Now a razor sharp 87, his favorite treat is the free Net Jet miles he gets from his son Bill every year. In his memoir Showing up for Life, he says a major influence was his Scoutmaster of 70 years ago. Being an Eagle Scout myself, I quickly drilled him on some complex knots, and he whipped right through all of them. The world needs more Bill Gates Srs.
?At some point in 2012, knuckles are going to be turning white, and we?ll see whatever rabbits Ben Bernanke is going to have to pull out of his hat?, said David Rosenberg of Gluskin, Sheff in Associates
After my regular dump on residential real estate, I feel obliged to reveal one corner of this beleaguered market that might actually make sense.
By 2050 the population of California will soar from 37 million to 50 million, and that of the US from 300 million to 400 million, according to data released by the US Census Bureau and the CIA fact Book (check out the population pyramid below).
That means enormous demand for the low end of the housing market?apartments in multi-family dwellings. Many of our new citizens will be cash short immigrants. They will be joined by generational demand for limited rental housing by 65 million Gen Xer?s and 85 million Millennials enduring a lower standard of living than their parents and grandparents. These people aren?t going to be living in cardboard boxes under freeway overpasses. Or maybe they will.
The trend towards apartments also fits neatly with the downsizing needs of 80 million retiring Baby Boomers. As they age, boomers are moving from an average home size of 2,500 sq. ft. down to 1,000 sq. ft. condos and eventually 100 sq. ft. rooms in assisted living facilities. The cumulative shrinkage in demand for housing amounts to about 4 billion sq. ft. a year, the equivalent of a city the size of San Francisco.
Fannie and Freddie financing is still abundantly available at the lowest interest rates on record. Institutions combing the landscape for low volatility cash flows and limited risk are starting to pour money in.
Got Anything With 3 Beds & 2 Baths and a Hot Tub?