This article is a guest contribution by David Rosenberg, Chief Market Economist, Gluskin Sheff.
It is rather amazing that there is still so much chitter-chatter of bonds being in a bubble. Just read the column in todayâs WSJ titled Bond Fund Managers See Signs of a Bubble. In the article, a strategist is quoted as saying âitâs fallacious reasoning that you canât lose money in bonds." Well, that statement is fallacious in its own right. While paper losses may have to be marked if yields back up, investors only realize a loss if they sell before maturity. Otherwise, it is ludicrous to talk about a bubble in a security in which the capital is fully secure and pays a coupon semi-annually.
How can anything be in a bubble in an asset class that is universally despised? Last we saw, about the only pundits who are remotely optimistic on the fixed-income market are Gary Shilling, Lacy Hunt and Van Hoinsington (great bond investors), Jan Hatzius (terrific economist) and Doug Behnfield (investment advisor extraordinaire).
In the discussion about the outlook for Treasury Bonds, the point must be emphasized that supply alone has been an inadequate focus for predicting future prices/yields. You donât have to do much more than go back to examples like these: the 30-year Treasury bond yield went from 4.7% to 6.7% in 1999, even though bond issuance by the Treasury was practically nil, and the decline in JGB yields over the last 20 years, even though deficit spending has been spectacular in Japan and debt-to-GDP is approaching 200%. The last I saw, the 10-year JGB yield was at 1.2%.
The problem with trying to assess either supply or demand in the current market environment is that everything is so confusing in the early stages of this new secular paradigm of a global credit collapse. There is no way to get it completely right. As Lacy Hunt has always maintained, it makes much more sense to assess the outlook for inflation as the primary effort in predicting Treasury rates. Simple and elegant. Or perhaps instead of inflation, we should really be discussing deflation, which has emerged as the primary trend, and governments have few bullets left in the chamber to deal with it.
Bond yields have been low for some time, and they will remain low. But don't be lulled into numerical micro-phobia (the fear of small numbers that plagues the bond bears). The near 30% slide in the Chinese stock market suggests that we have three to six more months of deflating commodity prices. And, if the trend in Japanese, German and Swiss yields are any indication, bonds in the United States and Canada have plenty of room to fall further.
COMMITMENT OF TRADERS UPDATE
The bull run in Treasuries is hardly overdone. At last count, the number of net speculative short positions on the CBOT with regard to 10-year note contracts totalled 153,407 (as of June 1st). To be sure, this is well below the 269,879 net short contracts back in mid-April when the 10-year note yield was sitting just below 3.9%. Indeed, we are seeing a huge (and painful) short squeeze but it is hardly over â the last time we had the 10-year below 3% back in April of last year, the net speculative short position was half of where it is today.
By way of comparison, we are huge bulls of bullion but we are concerned over the near-term outlook since this now looks like an overcrowded trade ⌠the net speculative long position is back flirting near all-time highs. The reality is that the gold could correct all the way to $1,112/oz (the 200-day m.a.) and it still wouldnât violate any long-term trend line. On a relative basis, the silver trade looks far less crowded.
The froth is off the Canadian dollar where the net speculative long position has been sliced by two-thirds on the CME since the middle of March to stand at its lowest level since early February â when it was close to todayâs level of 1.05. Even more froth has come out of the Aussie and Kiwi â the latter has seen just about all the net speculative long position it has enjoyed since April 2009 vanish.
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(c) Gluskin Sheff
