When to short US treasuries

Posted on 04 February 2010 with no comments from readers

Interest rates on US treasuries have sunk so low that all history suggests that a move back up will have to happen soon. In short, people will not lend you money if you pay almost nothing for the privilege, unless they are so scared that they have nowhere else to put their money.

Chinese and Japanese T-bond holders are also in a tight corner because as the world’s biggest holders of US bonds they also stand to be the biggest losers in a bond market sell-off, so they keep on buying.

However, market forces will apply. If the January stock market pull-back turns into a correction or crash then the demand for bonds will suddenly increase, and up will go the price. The trouble is that a stock bubble will be swapped for a bond bubble.

Biggest bubble

For how can the bond market be anything else, so puffed up by low interest rates has it become. And the bigger the bubble the bigger the eventual fall.

So shorting US treasuries at the right point has to be a winning stratagem. The only question is when to do it. Doing it now is clearly too early as the stock market still has to tumble, and bonds to rally further.

Should you therefore wait until all the good news seems to be in the market for bonds and all the bad news in the market for equities? That is quite a judgment call but at least extreme movements show up on the charts.

If seen as a once-in-a-decade asset allocation shift then this could well prove to be one of those obvious moves that you will later regret not having made. But if you are trying to ride dips that may or may not happen as you think then it could still go horribly wrong.

Short versus long

Going short is trickier than going long. It is a fact of investment life as the timing of options is usually involved in short positions and short ETFs are not the most reliable of instruments.

You might also argue that the switch to make from being long treasuries is to being long equities when the extreme overvaluation of T-bonds coincides with a low point for stocks. This would be the more classic asset swap.

The question then would be whether the shorting of T-bonds or buying equities provided the better upside return. Given how low interest rates have sunk on bonds and how far they need to go to revert to their long-run average, the better bounce does seem to lie in bond prices. So just be careful on timing.

However, ArabianMoney reckons buying gold and silver, and related equities, might be a much better investment than shorting bonds once stocks have fallen sharply, and we will return to this argument in the future on this website.