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May 28, 2009

A PUT on the US Government, an Important Update
by J.D. Rosendahl

On October 19, 2008, I wrote an article titled, "A Put on the US Government". I wrote that article because I felt then as I do now; the US bond market is potentially one of the next bubbles to crater. I also believe it's one of the largest bubbles on the planet and carries with it far more concerning consequences for humanity.

On January 6, 2009, I wrote an article titled, "5 predictions for 2009", and in that article I wrote the bond market would go through a topping process and begin to selloff.

Below is a monthly chart of the 30 Year U.S. Treasury Bond Market (In Price):

Back in October 2008, I felt the bond market looked poised to roll over and begin a serious correction. It did just the opposite, and reversed hard into what became the safety play as the stock market imploded, which ultimately caused a panic buying spike. The bond market retested its upper channel line (resistance) during this spike and the monthly MACD and RSI both made another bearish divergence.

In January 2009, I wrote that I thought the bond market would go through a topping process and then begin it's sell off. Ironically, we witnessed no topping pattern, and the bond market has begun to show serious signs of breaking down from its own weight, as the bull market looks tired.

Note: The bond market is still within its bullish trending channel so no long term technical damage has been done, yet.

That aside, the bond market is showing serious weakness, and this could be the move that ultimately breaks down the channel. Why?

We still have significant bearish divergences on the monthly RSI and MACD.
The monthly MACD lines are just beginning to roll over and cross, so we should expect a correction that last months or maybe a couple years.
If you look at the last few times the price of the bond market was at or close to the bottom channel, the month MACD was below zero and in the process of bottoming. Look at the price of the bond market to today and it's close to the bottom channel, but this time the monthly MACD is just beginning to roll over from over bought levels. I feel this is a serious divergence from the past, and a clue to the condition of the bond market.
The move down has been sharp or impulsive looking so far, and impulsive moves are usually followed by more moves in the same direction eventually.

What are we looking for as our confirmation? The only thing left in my mind is a break down below both the bottom channel lines. This would be a major signal that the bull market in the bond market is over, and we have entered a new bear market in bonds, and sadly a bearish tone on America.

For the record, I bought two short bond funds for my parents back in November 2008 when the bond market was roughly 116-118, which is where we are today. Yes, it was not a fun ride, but I've always felt any upside would be limited in either time or price, and it's turned out to be limited in time. I still like the short bond play, and my long term targets are:

80 is my primary target, which is the 61% fib. retracement area. This is a significant bull market and deserving of a significant correction. If you take the width of the channel, its roughly 30 points in width, and 30 points below the bottom channel lines (currently at 110) equals 80.
My secondary long term target is the 78% retracement area around 65. When this bubble unwinds it should be a whopper of a correction either in time or price due to the over supplied nature of the bond market. I'm thinking price, or maybe both.

Since we did not get the topping pattern I was looking for, but a rather sharp reversal, we did not add to our short bond position like I was anticipating.

It wouldn't surprise me one bit for the bond market to find some support in the area of the bottom channel lines before bouncing or consolidating. This would create the set up to finally take out the bottom channel lines.

IF THERE IS ONE CHART AND ONE CHART ONLY THE WORLD SHOULD BE WATCHING IT'S THE 30 YEAR BOND CHART! It simply comes with too many ramifications.

The most obvious impact is on the citizens of the U.S. We are simply not focused on what a potential correction in bonds will bring in the form of long term mortgage rates if the bond market corrects to my targets. As the 30 year bond price declines the yield will rise, and that will drag with it the yield on the 10 year treasury bond higher, which is what most mortgage rates are priced off, so we should also expect much higher mortgage rates in a declining bond market environment. Society has not priced into the value of real estate significantly higher mortgage rates with a declining bond market. Not too mention that higher rates will probably occur just prior to or at the same time higher tax rates are implemented by Uncle Sam, and no one on the planet is discussing this potential issue, it's huge.
If you think for a moment real estate has bottomed, think clearly again. If either of the two or both the above occur, we have a lot more room to go on the downside for ever type of real estate, I'm thinking another 30-50% from today's level if we get higher interest rates and higher taxes. And as the real estate market goes, so goes the overall economy, as we have learned the hard way.
At the crux of a deflation spiral, there should be a significant real estate correction that is far greater than anyone could imagine, and the combination of higher taxes and higher mortgages rates are definitely some of the possible factors I see forcing a deflationary spiral in the next 3-5 years.
Gold: As money pours out of bonds, it will ultimately need to go some where. The one asset that held up the best in 2008 was gold, and I'm a firm believer that gold will be the last bubble before we start the deflationary spiral. In essence, it might be viewed as the last safe haven for money that will force the majority into the asset causing a spike or bubble phase right before we enter the deflation spiral. If you look at some individual junior miners the past few weeks or months, they have been rallying with the metal as the bond market has been selling off.
Social: A significant correction in the bond market will probably signify the end of the U.S. at least to some degree as the main global super power. It may also be the trigger for a movement of protectionism between countries. A correction in the bond market should precede the movement of social unrest and change within this country.

THIS IS THE MARKET WE SHOULD BE WATHCING, IT'S FAR TOO IMPORTANT AND IT'S ON THE VERGE OF SENDING VERY SERIOUS WARNING SIGNS ABOUT EVERY WALK OF LIFE IN AMERICA.

Hope all is well.

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.