The Treasury Bubble is Beginning to Pop -- Here's How to Profit From it Right Now

     If there's one thing for certain during a severe economic downturn, it's that investors will run in droves to find a safe haven. One of the first havens investors flee to is U.S. Treasuries -- understandable because they are one of the safest investments on the planet.

     This time around, Treasuries have had a truly remarkable run. A run too good to last. Investors have been so desperate to keep their money safe, yields have actually approached zero (and even dipped below that) on a few occasions. But all of that is about to change.

     Profiting by betting against one of the world's safest investments sounds like insanity. But there is a confluence of factors on the horizon that will likely weigh on the demand for Treasuries. As these factors come into play, they will push Treasury prices down and yields back up -- manufacturing significant gains for those wise enough to spot this reversal.

     Before we get into how you can profit from the pop in the Treasury bubble, let's first understand how it's happening and why.

     Take a look at this chart of the iShares 20+ Year Treasury Bond ETF (NYSE: TLT). As you can see, this bubble has already started to pop. And there's no reason to think that Treasuries are headed anywhere but down from here.

     As most of us know, price and yield move in the opposite direction. When the bottom fell out of the market, investors fled to Treasuries and demand was so high that yields plummeted to 50-year lows. People were so desperate that they actually accepted negative yields, meaning they were willing to lose a little bit just to park their cash somewhere.

     This is why legendary bond investor Bill Gross called Treasuries "the most overvalued assets in the world, bar none."

     The only reason it would make sense to accept such a low yield would be if you expected a sustained period of deflation. But given Uncle Sam's desire to print money and hand it out like it's Christmas, that's highly unlikely. Once stimulus money starts flowing, Washington will have to issue more debt to pay for it. In fact, they've already started. As new Treasury issues continue to flood the market, valuations will come under intense pressure. In fact, the market has already seen some softening in demand.

     Warren Buffett recently called holding long-term government bonds a "terrible policy if continued for long." Buffett believes the dollar will continue to devalue -- at an even faster rate once inflation picks up again -- leaving bondholders stuck holding the bag. And he's not alone in his thinking. 

     Another reason this bubble won't last is because other countries are getting tired of giving the U.S. government a free ride. At least half of U.S. Treasuries are held by foreign investors, and other countries (particularly China) are becoming all too eager to voice their displeasure over holding these ticking time bombs. They see the same thing Buffett and Gross are seeing -- a government that is spending like a drunken sailor. Don't be surprised when these governments say "no" when a new influx of Treasuries hits the market.

     Put it all together, and you have a bubble that is waiting to burst. When this bubble pops (and it has already started to leak), there is an opportunity to short U.S. Treasuries and score big. From almost any perspective, this seems to be a play that makes sense.

     If you believe that current levels of government spending are unsustainable and Treasury prices will continue to plummet amid the specter of higher inflation, then shorting Treasuries looks pretty good here.

     But you don't even have to be a pessimist to like this trade. This play will also profit at the first signs of an economic recovery. As investors start to feel more confident, they'll quickly abandon paltry yielding Treasuries for higher risk, higher-return investments.

     The only way you can lose? Well, if fear continues to rule the markets, demand will continue to be high. But fear can't rule forever. Even if rumors that the Fed will start to buy Treasuries are true, sooner or later, investors will come to their senses and start to shop for bargains.

     Either rising inflation and/or an economic recovery will send Treasury prices lower. When that happens, you can profit by holding shares of ProShares UltraShort 20+ Year Treasury ETF (NYSE: TBT). TBT is an ultra-short ETF designed to return double the inverse of the Lehman 20+ Year U.S. Treasury Index; meaning if prices of long-term Treasuries decline -10%, TBT should go up about +20%.
    
     This is about as close as it gets to a can't-miss trade. Nathan Slaughter, editor of StreetAuthority's The ETF Authority, added shares of TBT to one of his portfolios in January. So far it has gained about +20% in less than two months.

     If you glance above at the chart again, you'll see that long-term Treasuries still have a way to go before they revert back to their historical valuations. They'll at least do that -- and there is enough evidence to think they have even further to fall.

     Good investing!


 


-- Brad Briggs
Staff Writer
StreetAuthority Investor Update

P.S. Nathan's call on the Treasury bubble is just one of the opportunities he has found for readers of The ETF Authority. At the onset of the downturn six months ago, Nathan flagged 14 securities engineered to deliver profits in a down market. Since then, 12 of the 14 are showing positive gains -- with one returning +402%! To find out more ways Nathan has found for his readers to profit in the market right now, click here.

Estimated amount of debt sales issued by the U.S. government this year, triple that of the previous year.

-- Goldman Sachs

"The global economy is likely to shrink for the first time since World War II and trade will decline by the most in 80 years, the World Bank said yesterday. Its assessment is more pessimistic than an International Monetary Fund report in January predicting 0.5 percent global growth this year."

-- Bloomberg

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