Watch the Birdie?

TBT is the symbol for the ETF that tracks the long bond, but in inverse.  In other words, it shorts 20-30 year US bonds.  As interest rates rise on the long end so will TBT, but double the rate due to it’s leveraged position.

When the economy caved so did interest rates and TBT.  It fell from over 70 to under 40.  As the economy has recovered so has TBT.  I picked it up at 38 in January of 2009.  I rode it to over 50 and sold it.  Since then it has traded in the mid to high 40’s.  TBT will either move up or down depending on the supply of and demand for long bonds, the degree of economic expansion, and inflationary expectations, or lack thereof.  If one is going to take a position in TBT, it becomes crucial then, to have a view of what the economy will look like 6 to 12 months into the future.

My view of the economy for some time has been that this year would be pretty good; that economic growth would be better than expected, inflation moderate, and that the stock market and, in fact, all markets would move up as the economy recovered.  But my fear has been at some point the markets would begin to discount increased debt, increased prices, and increased taxes.  The move upwards this week in TBT may be indicating that the time has come.

When interests rates increase in earnest all markets will be in jeopardy.  The stock market will probably fall, commodities could possibly fall, and the recession/deflation bias will most likely return.  My hunch has been this will begin this spring or summer.  We are entering that period now in what I think will be the last leg up.  Initially a move up in rates will be considered a return to normalcy, so there shouldn’t be an immediate reaction.  But as rates continue up they will become problematic for markets.

There is little doubt that the government has no interest in addressing the deficit problem we face let alone our unfunded liabilities of some 67 trillion dollars until forced to.  It will be the market that will force them.  Watch TBT.  It is the canary in the coal mine. It is one indicator that will signal trouble ahead.  All of the domestic dreams that we can not afford are about to collide with the reality that this nation technical insolvency.  We can’t know how and when the markets will deal with this fact, but a rise in TBT will be one indicator that we are getting close.

Mostly it has to do with servicing our debt.  The more debt we pile up the more it costs us.  Interest rates reflect investors confidence in our ability to pay over time.  If the interest rates on Greek debt is any indication, the US has a long road ahead of it.  The first barrier to test is the 10 year bond crossing 4%, then 4.25%.  Anything above that and I believe we will get a market reaction.

Higher interest rates will probably be accompanied by higher taxes and spending cuts all of which will reduce future economic growth.  It’s a fiscal train wreck waiting to happen. My guess is that 2011 will be the year when the piper will have to start being paid.

I have not yet taken a position TBT but I’m monitoring it closely. I sold out my positions in RBY as it broke through its 200 day moving average and sold CDE at my buying price.  No harm no fowl.  I am in almost all preferred stock and cash at this point. The markets are not showing me a trend or a buying opportunity that I can play.  Hatteras declared a 1.20 dividend again and will pay out what amounts to another 17% annual rate of return for the quarter.

Sitting on cash and cash equivalents feels right to me for the time being.  Next week should bring more clarity.

Paul Nathan has specialized in gold and gold stocks and has written extensively on monetary and economic matters since 1968.  He also writes a weekly blog and can be contacted at paulnathan 2000

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