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October 19, 2008

A "PUT" on the US Government: Chart One of Three Important Charts
by J.D. Rosendahl

There are three important charts we should all keep our eyes on, and the first of those three is the 30 Year UST Bond. Why? It's on the verge of a large correction!

The chart above is the weekly chart of the 30 Year UST Bond over the past 10 years. This chart reflects 2 bearish indicators. First, we have a failed break out to the upside during the 3rd quarter of 2008, and a quick reversal back under resistance. Secondly, we have bearish divergences on both the MACD and RSI, and both have rolled over heading downward.

Above is the monthly chart of the 30 Year UST Bond over 28 years.

1. Most secular bull markets in any asset usually have a dominant trend line that is obvious to all to see. The 30 Year UST Bond market definitely has a strong trend line for the past 28 years.

2. Notice how the peaks in MACD and RSI have declined on each consecutive new price high in the bond market. That's classic bearish divergence on a grand scale over 28 years. That is a bearish sign for the price of the long bond.

3. These three lines represent the Fibonacci retracement levels. Price levels we should expect to see before the correction in the long bond is over.

Technical Summary: The bond market is displaying some early warning signs of a correction coming in the long bond price. A possible false break out, bearish divergences in the MACD and RSI, and the MACD on the monthly chart is about to turn down and cross over. The signs are early warning signs simply because the massive trend line has yet to be broken.

POSSIBLE CAUSES FOR DECLINING BOND PRICES

1. The first possible reason bond prices might fall is from foreign governments selling their US Treasury Bond positions. Some foreign Governments have very large UST Bond portfolios, and they could sell these assets to diversify their reserve holdings, or sell on a lack of faith in the US in general, or because they might need to support their own problems at home and want to raise liquidity.

2. The US Gov't. That's right, we have serious problems here at home, and the federal government could issue 30 year bonds to fund the money they are going to pump into our system in an attempt to hold up our economy. That new potential supply would adversely affect bond prices.

3. Lastly, in the recent financial damage, raising liquidity is becoming important, and hedge funds, mutual funds, pension plans, etc. could sell UST bonds to raise liquidity, or sell UST Bonds to take gains that they can net off stock losses. Lastly, some investment houses might short the UST bond and buy government backed toxic paper as a pair's trade.

Summary: To cause a correction in bond prices of a large size as I expect, bonds in volume will need to be sold while demand diminishes. It's been my experience that chart/price patterns usually lead the news, so I expect the correction in bonds to start before we find out why. I expect the smart money is selling now before we break the massive trend line, and when the price of the long bond breaks below that trend line that will trigger technical selling, and as we approach the 200 month moving average and below we will see panic selling.

FINANCIAL IMPLICATIONS

1. The first implication of declining bond prices is higher long rates. Bonds and rates have an inverse relationship. As bond prices come down the yields on those bonds will go higher.

2. As long rates go higher, the cost to borrow money especially on homes will go higher. A great deal of the mortgage market rates are set off the 5 and 10 year UST bond yields, which will trend higher with the 30 year bond yields.

3. As mortgage rates go higher the cost of home ownership related to financing will rise, and thus should place additional downward pressure on real estate values. Just what we need now!

OTHER POSSIBLE IMPLICATIONS

The UST bond market is so large, and the popping of this bubble has possible global implications, which include the possible start of global protectionism between countries, the loss or diminish of the US as the premier global leader or financial power, and a possible rejection of the Western lifestyle in general.

INVESTMENT OPPORTUNITY

Lastly, I look at a lot of charts, and I feel this chart provides an exciting investment opportunity, which is the short of the UST long bond or the purchase of an inverse long bond fund. I currently like this trade more than any other I see, because the bond market has limited upside of $5-10 in my mind and possible downside of $10-30. That represents a 2:1 and up to 6:1 reward to risk opportunity for your investment dollar.

Currently, the bond market sits right at its 50 month moving average, and a breach of that area should send the bond market down to again test its massive trend line. A break below that is the confirmation that the trend is over and a larger correction is underway. Shortly there after the bond market should test it's 200 moving average, which on the bond market is about 101, or a about a 10 percent correction from current levels. If we correct down to the Fibonacci levels the correction will 2-3 times that, and provide very strong returns.

So, if you ever wanted to own a PUT on the U.S. Government this is your opportunity!!!

J.D. Rosendahl

J.D. Rosendahl is not a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible sources. Of course, we recommend that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, we encourage you confirm the facts on your own before making important investment commitments.

Copyright © 2008-2009 J.D. Rosendahl

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