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Bond King Bill Gross uses a false story about frogs to promote a false story about bonds

June 2, 2011 7 comments

I was unable to find a picture of a real world frog accepting its boiling fate. I had to use a picture of a plush toy to illustrate my sophisticated point about financial markets and economic reality.

You’ve probably heard about the recent missive from bond king Bill Gross, the largest bond fund manager in the world.  He compares bond investors to boiling frogs.  We’ve all heard the story of the boiling frogs, how they will just sit in a pot of gradually heating water until they perish from the heat.

Unfortunately, this well known story about Boiling Frogs is not true at all.

Here’s Paul Kedrosky at Bloomberg pointing this out:

“This is me being more than a little pedantic, but I’m picking a personal nit here. In his latestmissive, PIMCO bond guy Bill Gross tells the following well-worn story:

Put a frog in a kettle of boiling water and he’ll jump out faster and further than any of those blue ribbon winners at the Calaveras County jumping frog contest. Put him in a pot at room temperature, however, slowly turn up the temperature to boiling, and you’ll have frog legs for dinner. This latter, more unfortunate toad temporarily adapted to his external environment, which seemed like a practical thing to do, until – well, until he reached 212° at which point he was cooked.

Gross goes on to suggest that bond investors are acting the same way, that the environment is becoming more hostile and yet they wait and are steadily being boiled, so to speak. Well, Gross must be the last person on earth who still thinks that old boiled frog story is true, because it isn’t. Frogs don’t behave that way, even if it’s lovely fun to pretend they do.”

Ha!  Bill Gross is comparing the behavior bond investors to a behavior of frogs that doesn’t exist in the real world!  It’s almost like believing a story about insolvency that cannot exist!  Or believing in something we can never know!  Or denying that Debt to GDP and Bond Yields are negatively correlated!

I’d like to point out that I can hardly wait until Bill Gross is the last person on earth to believe that government deficits cause higher bond yields.  We will all be much better off.

BTW, I said a a month ago Bill Gross will be the one to push bond yields down to the post crisis lows when he has to cover his huge mistake in getting rid of Treasuries.  Mike Norman’s picked up on it.

The answer to Bill Gross’s question of “Who will buy bonds when the Fed doesn’t?” is: Bill Gross

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What does a Commodities Bust mean for the U.S. Dollar? Not what you’d think…

June 1, 2011 4 comments

PSI

We could see the start of a commodity meltdown tonight.  The oil market is extraordinarily fragile right now, and commodities are not looking healthy at all.

Of course you’re paying attention to the price of Silver, Gold, and Oil.  It’s impossible to fill your gas tank without noticing the huge hit to the wallet.  And Silver has been just going crazy until just a few weeks ago.

There is a huge clamor from people who don’t know how money works that the weakness of the U.S. Dollar is due to the actions of the Federal Reserve.  Zero Hedge is just one of the nuttiest, but you can find this claptrap everywhere.

It’s undoubtedly the wrong model, but it is the dominant model.

The conventional wisdom model in a paragraph: Quantitative Easing is – must be – shredding the value of the U.S. Dollar.  As proof of this astonishing, irresponsible behavior, Commodities are prudently rallying, because commodities are iron clad protection against the inflation that is certainly just around the corner.  Commodities are not in a bubble, their dramatic increase in price is a rational response to a near-worthless U.S. Dollar.  Other Currencies – the euro, Swiss franc, and Australian dollar, are also rallying because of the irresponsible fed.

It’s a convincing argument when commodities are in rally mode.  But Commodities are no longer in rally mode.  We could be seeing the start of the crumble right now, tonight.

In the last few weeks, Silver took a serious tumble.  A 20%+ drop in 3 days is a huge move for any market.  Not only that, but Silver could be forming a “flag” – a technical formation that predicts a further huge decrease in price.  This isn’t guaranteed – but it is something to watch.

People are beginning to question if Commodities will last.  Perhaps commodities are in a bubble.  We have had enough bubbles in the last few years – why not Commodities?

There is ample evidence that Commodities have a large speculative bid.

I focus on oil and copper because these two commodities only make sense to buy them if you are going to use them.  If the reason Copper is going through the roof is to prop up what appears to be a massive credit bubble in China, then we need to monitor signs the Chinese Government is cracking down on the practice.

And it appears China is cracking down on the Copper financing practice.  In a few months, this source of financing will go away for Chinese companies and speculators.  It appears that China has several years worth of Copper imports sitting on the ground being used as a way to borrow money very cheaply.

It makes sense to ask what would happen to the U.S. Dollar if there is a significant correction in the Commodities market.

Would a correction in the Commodities market be a bullish sign for the U.S. Dollar? 

The selloff in Silver could be the trigger event that causes a massive selloff in the entire commodities complex. It could cause a total rethink of the market consensus.

We are seeing this in price action today with oil going down, the Euro holding steady, and Swiss franc going through the roof. Commodities are correcting across the board, but the Currency markets are mixed.

If the commodities sell off, the primary proof the U.S. Federal Reserve is out of control will be far less potent. So what happens to the U.S. Dollar?

The conventional wisdom is that the U.S. Dollar must become stronger if commodities become weaker.  I am not as convinced about the link between the weak U.S. Dollar and the large increases in Commodity prices.

This is not to say there is no link between Commodities and the U.S. Dollar. If Commodities enter a correction, the U.S. Dollar could rally at least some.

Still, two data points give me pause:

  • U.S. Dollar Index and Commodity index out of sync over last decade
  • Massive speculation in Commodities covers up moderate real demand

The U.S. Dollar is roughly 8% weaker than it was in late 2005. In December of 2005, the U.S. Dollar index hit 80, vs. a price of 73.10 today. However, the CRB index is 130% higher than it was at the end of 2005.  You’d think that when the U.S. Dollar lost a ton of value, the CRB would have risen a proportionate amount.  It didn’t.  The spectacular rise in the Commodities came long after the U.S. Dollar had its most dramatic losses.

I’ve created a model of currency valuations based on the principles of MMT.  The model says the EURUSD should be much higher than it is today – perhaps as much as 20% higher.  I have kept the last few years of data of this model to myself.

But why am I talking about this?  Because if the Commodities fall but currencies rally, the conventional narrative cannot be true. But some other narrative must be. MMT provides a narrative that accommodates Commodities going down and the USD going down.  

The MMT narrative about the Commodity rally is that it is nearly all speculation based.   Warren Mosler says much of it is due to the huge inflows into long only commodity funds.  I agree with this narrative.  But MMT does not have a currency model – at least not a public one.  😉  I do have a model, based on MMT, that says most currencies around the world have a reason to be stronger against the USD.

Even the pathetic Euro – that messed up, fatally flawed currency – has a powerful reason to rally against the USD.    

This blog is called the Traders Crucible, after all.  Some forms of fundamental trading are applied economics.  Fundamentals of the currency markets fall into that category.

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Bonds: Head and shouderish getting some notice

March 14, 2011 Comments off

30 Yr Inverted Head and Shoulders?

I wrote a post on the head and shoulderish formations in the long bonds and 10 year. This was now noticed by dshort and Chris Kimble.   The bonds are very close to breaking out higher during risky times – this could be a huge “risk off” trade.

But given this potential rally in U.S. Treasuries, what is going on in the Euro today?  It is strong even in the world wide “Japan will repatriate money” trade-o-the-day.  How does this match with U.S. bonds completing this potential head and shoulders?

Curiouser and Curiouser…

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QE II: The Fed’s “Cash for Clunkers” Program – and why the End of QEII means “The Godzilla of all Bond Rallies”

March 11, 2011 12 comments

Remember the “Cash for Clunkers”?  The U.S. Government gave people money for their old cars and helped to temporarily boost  auto sales.  The criticism of this was that it wouldn’t boost auto sales in the long run – all it did was move future sales into the current period.

I am starting to think that QEII does the same thing with Treasury debt. It pushes potential sales of Treasuries forward into the actual period of QEII.

If you were looking to sell $50bn of Treasury bonds in August, wouldn’t you at least consider moving the sale forward a few months, and selling those bonds in May or June?  Who wants to sell during one of the all time great bond selloffs?

The U.S. Federal Reserve has stated they would buy truckloads of bonds during QE II.  So you know you can go into the market and sell, sell, sell – without any real impact on market prices.

And if you’re considering selling Treasuries in May, why not sell them today?  QEII might be suspended…and who wants to sell during one of the all time great bond selloffs? Why not sell them before that happens?

I think that every asset allocator in the world who is even considering selling Treasuries this year will do it earlier rather than during one of the great all time bond sell offs.

It’s cash for clunkers argument applied to Treasuries.  It turns out that the critics of Cash for clunkers were correct – car sales did slow after CfC ended.   Basically, it pulled a bunch of car sales out of the future and into the time frame of the Cash for clunkers program.

The Fed’s QEII is a great opportunity for weakly committed holders of Treasuries to exit their positions.  There is a known huge buyer of Treasuries in the market – why not sell to that known huge buyer?

I suspect this same thinking has something to do with the huge rally that happened at the end of QE I as well.  If you recall, there was nearly universal bearishness for the post-QE I bond market, but the day it stopped, bonds went on a historic rally.  All of the sellers had already sold when they knew the Fed would be there – so only natural buyers were left in the market.

Bond Yields aren’t an exact science.  The Yield Curve reflects the future path of short term interest rates – which is a huge problem for the Fed.  So anything done by the Fed won’t have much impact – and even worses,  is likely to be counter productive given the current dominant paradigm about how money is created.

The mother of all Bond Rallies at the end of QE II

If you look at the dynamic of QE I, you’ll find that during the actual QE, bonds got crushed.   When QE ended, bonds rallied because there were no more sellers.  The post QE I rally was substantial, and Treasuries continued until Bill Gross started selling bonds in his funds due to discussions of QE II.

QE II is discussed, and Bill Gross decides to get out of Treasuries, Treasuries fall.  But curiously, Yields have not been able to make new highs yet.   These weak holders exiting positions are not able to shove yields higher.    So far it looks like inflation expectations are anchored quite well, and that the future path of rates has not been impacted that much.

Now, consider the  post I just had about the radical ineffectiveness of Japan’s QE?  Japan was mired in deflation for most of their QE – and only peaked their head into moderate inflation during one of the great energy spikes of the last 100 years.

All of the weak holders of Treasuries will get out while the Fed is buying.  When the fed is done buying, there will not be any sellers left for the first few months at least.  This of course gives a boost to the bonds for a few months.

And then it starts to become really obvious that QE I didn’t cause inflation, and QE II isn’t causing inflation, because QE doesn’t cause inflation.  So expectations of future rates shift downwards, adding a boost to the bond rally.

Godzilla awakens.  Welcome to 2% long bond yields in June next year.

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Is Bill Gross Anti-American?

March 5, 2011 1 comment

Bill Gross says lots of things that are wrong. Wrong enough to put him close to being anti-american. I am still quaintly idealistic enough to believe things like “with great power comes great responsibility” and “people have a responsibility to help their government”

Bill Gross is one of the greatest bond traders of all time. He runs the largest bond fund in the world, and the largest company devoted to trading fixed income in the world.

Here are 3 things that Bill Gross also knows – if I know them, Bill Gross frackin’ knows them. And that he isn’t talking about them is dangerously close to being anti-americian.

1. Pimco caused most of the bond selloff late last year. When Pimco sold somewhere between $120-$400bn of U.S. Treasury bonds over 2 months, it caused a huge decline in the price of Treasury bonds. The selling done by Pimco was larger than the buying by the U.S. Fed so far, and done in a shorter amount of time. The amount of selling is one of the great position dumps in human history – there may have never been a larger sale of treasures by any entity in such a short amount of time.

2. The bid to cover across the entire yield curve has been high, strong, and healthy. Even if the primary dealers cut out .6 of this when the fed goes away June 30th, the bid to cover is still healthy. So in other words, there will be plenty of people willing to buy Treasuries.

3. The Feds purchases are large enough to buy 100% of the issuance by the treasury, but they are only able to purchse 70% of it. In other words, foreign countries are extremely aggressive in their bids. When the fed goes away, these foreigners are signalling they are very willing to buy much more treasuries.

With great power comes great responsibility.

Here are three other questions for Bill Gross:

1. When Pimco was selling its bonds, why was it talking about the threat of deflation in media outlets? Does this violate SEC trading regulations? Is this a material misrepresentations of what you are doing in your fund?
2. At what yield is Pimco willing to buy Treasuries? As Gartman famously said, at some price every instrument is a sell, at some other price every instrument is a buy. I know getting an honest non-bs answer is impossible out of Gross. But what is a good, fair value for treasuries right now? The greatest bond trader of our time has an opinion about this. The largest bond fund manager should not be able to make material representations about his opinion on Treasuries on national media outlets over and over and over.
3. Are there any other institutions with over more than $500bn in Treasuries who will be selling their entire position in the next year? China? Japan?

I know we sovereign types are insufferable bores. But hell, don’t you ever get tired of listening to the bond vigilantes be wrong for decades and decades across multiple countries? Bond vigilantes have been wrong for longer than I’ve had pubic hair. The White Sox won the world series and i didn’t even care anymore – I’d grown out of watching sports! I had kids and the oldest is 9 years old. I went from kid crew cut, to long indie rock hair, to balding enforced crew cut. We had 2 gigantic asset bubbles.

And bond vigilantes have been wrong the entire time – always warning the sky is about to fall. I’d call that hugely boring. fool me once, shame on you. Fool me 30 times, shame on me.

MMT explains why bond vigilantism is boring.

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Bloomberg: Treasuries rallied because the Fed bought a truckload

January 28, 2011 2 comments

Check out this article from Bloomberg that says Treasuries rallied because the Fed bought billions of Treasuries. The Bloomberg reporter didn’t think of this idea – he just wrote down what his buddies on trading desks told him.*

That’s exactly what I said would happen. I thought this would be common knowledge by now, but people still seem to be surprised when it happens.  The fed just confirmed that they will go through with the entire QE II no matter what happens – and people were shocked by that too.

This shows that the idea of the Fed buying a ton of Treasuries over 6 months is beginning to get traction on trading desks.  This has the potential to be a big, big move.

From this handy chart from the Fed, we can see that next week, there will be a few more days of large purchases. And then they will release information and dates for even more purchases on Feb 1oth.

I like the idea that people are getting out of Notes and Bonds because they have someone to sell them to, and that this pushes people into risky assets so might defeat the purpose of the QE entirely.

But who cares? The Fed is just buying and buying Treasuries left and right.  Why fight the Fed?

*(Every Bloomberg employee I’ve met is sharp and works their ass off. This isn’t a slam on the reporter – he was reporting what the people on the trading desk told him as is his job.)

30 Years cannot make lower lows even the worst days, but is the 10 year making a flag in yield?

January 26, 2011 Comments off

The bonds have sold off very, very strongly a few times over the last few months.  You can almost feel the glee of the “higher Yields!” crowd radiate from the screen on these days.  But even on these selloffs, bonds haven’t made new lows.  The lows for each of the down days have been 1 or 2 ticks higher than the prior low.  They just cannot muster that final push to actually make a new low.

Lows:

  1. 109-09  on 1-20
  2. 109-08 on 1-05
  3. 109-06 on 12-28
  4. 118-21 on 12-15

Remarkable.  But on the other hand, the 10 year is making what appears to be a flag in the weekly chart of yield.  This is something to watch.  The breakout from that formation could be quite powerful.    This is a flag because of the quick runup in price, but it could also be considered to be a wedge formation.  In either case, this rapid movement followed by consolidation tends to mean that there is lots of “energy” stored up in the formation.  Once one side capitulates, the movement out of this formation could be large.

I am really bullish bonds and bearish yield, but this formation could just as easily explode higher as it could lower.

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