Newsletter #119 01/30/2013
“Will the Bond Market Melt Down in 2013?”
“The ongoing circus in Washington has grave implications for the US bond market, and therefore for your investments as well.
“This month: the three major threats to the bond market, and three paths to making big profits from the current turmoil!”
“When written in Chinese, the word crisis is composed of two characters. One represents danger, and the other represents opportunity.”
John F. Kennedy, in a speech on April 12, 1959
If any two words describe today’s investing climate, they’re “danger and opportunity.”
The list of dangers is long, and growing. But where there is danger, there is also much opportunity.
When markets are overcome with fear, large moves are possible in a short time. And large moves can mean large profits.
That’s our theme in this issue: the big dangers and big opportunities that await us in 2013.
We’ll start with a brief look at...
The Fiscal Cliff Fiasco
In late December, with the fiscal cliff fast approaching, Washington finally faced a hard deadline.
They had kicked the can down the road again and again—but this time, they had run out of road.
That’s why we all cheered when both political parties decided to serve the higher good—the American public—instead of partisan politics.
And we all breathed a huge sigh of relief when Republicans and Democrats agreed on a viable solution—not just to the short-term fiscal cliff, but also to solve the grave long-term financial woes that were crippling America.
Of course, none of that actually happened.
Rarely has Washington’s inherent dysfunction been so clearly revealed as it was last month.
Even with clear threats facing America, and a hard deadline for avoiding them, Republicans and Democrats still couldn’t get the job done.
Yes, some legislation got passed and signed into law. But the “solution” was fake. A farce.
The deal solved nothing. It raised $60 billion per year in new revenue but didn’t cut spending significantly.
And there was also what the Wall Street Journal correctly described as...
“The bill’s seedier underside... the $40 billion or so in tax payoffs to every crony capitalist and special pleader with a lobbyist worth his million-dollar salary.”
President Obama announced that the new bill would require “millionaires and billionaires” to finally “pay their fair share.”
Unless, of course, the millionaires and billionaires owned NASCAR racetracks. Those millionaires and billionaires got $78 million in tax breaks.
Ditto for large distillers who make rum. They got $222 million in tax rebates.
And let’s not forget algae growers, who got $59 million. Or builders of energy-efficient homes, who got $154 million. Or the $62 million given to companies operating in American Samoa (a vital sector of the US economy).
Or the $650 million in payoffs—excuse me, I meant to say ‘tax breaks’—to manufacturers of energy-efficient appliances. Surely, Whirlpool and Maytag deserve to get hundreds of millions of dollars of handouts from the American taxpayer.
And there’s the $430 million in kickbacks—oops, slipped again—to Hollywood movie studios.
After all, if anybody deserves corporate welfare, it’s Hollywood filmmakers. Without it, they’d actually have to make good movies. That would be unacceptable.
The fiscal cliff bill was stuffed full of pork and corporate payola like this. All told, there was about $40 billion of it.
It’s hard to imagine a clearer example of...
Washington’s Corruption and Incompetence
Instead of solving our nation’s financial woes, this “fix” makes things far WORSE.
Under this legislation, over the next 10 years, spending will rise $330 billion. And America’s national deficit will rise by an additional $3.9 trillion over the next decade.
You’re probably sick of hearing about this, as am I. But we can’t ignore this fiasco.
It’s an excellent example of why...
The Bond Market is in Serious Jeopardy This Year
The global bond market is enormous. According to McKinsey & Co., it’s more than $150 trillion worldwide. The US bond market accounts for about $37 trillion of that.
A disruption in this market—especially in US Treasuries—would be catastrophic.
Bond prices move inversely to interest rates. If bond prices plummet, interest rates skyrocket.
Right now we’re enjoying some of the lowest rates in generations. But even with rates at rock bottom, our economy is struggling to recover.
As I discussed in the November issue, higher rates would be a disaster. Skyrocketing rates would rip gaping wounds through our economy. There would be wave after wave of business failures, plunging stock prices, and more.
But with rates at historic lows, there’s only one direction to go—up. The only question is when rates will rise, and how far up they’ll go.
As investors, we need to anticipate future events in the markets. And right now there are...
Three Major Threats to the Bond Market
Each of these has the potential to trigger a plunge in part or all of the bond market. And each has the potential to detonate in 2013.
We’ll start with one that’s getting lots of publicity lately, but not necessarily for the right reasons.
Threat #1: The Debt-Ceiling Crisis
The US has once again reached the limit of its national credit card. Federal debt has reached a staggering level: $16.4 trillion.
If Congress doesn’t raise the borrowing ceiling again, the US won’t be able to drive itself any deeper into debt.
Of course, more debt isn’t mandatory. There’s nothing requiring our nation to borrow more money.
In theory, we could freeze the debt at its current level.
In theory, Congress and the White House could agree on a balanced budget—one that no longer requires us to borrow an additional $1 trillion per year.
In theory, Rush Limbaugh could fund a campaign to elect Nancy Pelosi as the President of the United States.
Obviously, none of those things will happen.
So, Congress is preparing for a bare-knuckle brawl over raising the debt ceiling.
Many Republicans are vowing to block any legislation without significant spending cuts. They got spanked recently by angry constituents, who were outraged that the fiscal cliff bill raised taxes without reining in spending.
Meanwhile, Democrats were taken to task by their liberal constituents, who wanted more spending and higher tax hikes than the legislation contained—not to mention the disgusting corporate welfare that was stuffed into the legislation.
Both sides are hardening their positions. They’re already throwing harsh words at the opposition: words like dangerous, financial disaster, and absurd.
A nasty fight is on its way. It probably won’t happen immediately—as this issue goes to press, Republicans are planning to delay the fight by a couple of months. (This will force Democrats to take their share of the blame for this whole mess.)
A delay is a good thing. Maybe the extra time will help us to avoid...
The Debt-Ceiling Threat Nobody Wants to Talk About
Last month I said that if Washington didn’t create a real solution to the fiscal cliff, our nation would lose whatever financial credibility it had left.
The so-called solution was of course a farce.
Washington’s criminal mismanagement of our national finances was exposed for the entire world to see.
And that was just Round One of a multi-round fight. The debt-ceiling battle will be Round Two.
Again, the world will see that America’s fiscal crisis is spiraling out of control. Again, the world will see that Congress is helpless to stop it.
And this will pressure the world’s ratings services to downgrade US debt.
As David Riley (head of Fitch Ratings’ sovereign-rating team) said recently, another “self-inflicted crisis” in Washington “will put into question the predictability and reliability of our policy making when it comes to fiscal policy...
“Living hand to mouth based on robbing Peter to pay Paul... that’s not what we associate with a triple-A rated government.”
Fitch Ratings has even said that it might downgrade US debt—even if the debt ceiling gets raised—if Congress can’t rein in its runaway deficit spending at the same time.
The other two ratings agencies (Moody’s, and Standard & Poor’s) have said similar things. In fact, S&P has already downgraded US debt, thanks to the previous fight over the debt ceiling.
If the other two agencies do it too, then we could see...
A Massive Selloff of US Treasuries
Many large financial institutions are obligated to hold only top-rated debt instruments. Once Treasuries no longer meet that requirement, they’ll get dumped—not because the institutions want to sell them, but because they’ll have no choice.
Treasury values will plummet. Rates will soar.
But what if Congress manages to (somehow) agree on legislation that will raise the debt ceiling? As we just saw, it might not matter. The agencies might downgrade US debt anyway just because Congress has botched up America’s finances so badly.
And even if they don’t, there’s...
Threat #2: The Federal Reserve Might Crater the Bond Market
The Fed has been propping up bonds in an unprecedented way. In fact, “propping up” doesn’t begin to describe it.
During 2013, the Fed plans to buy 77 percent of all net issuance of Treasuries, agency mortgage bonds, and investment-grade corporate bonds.
At that rate, the Fed isn’t propping up the bond market. The Fed is the bond market.
And that’s why...
The Fed’s Recent Announcement Shocked Everybody
The minutes of December’s meeting of the Fed’s Open Market Committee (FOMC) were recently released. They were a rude jolt to investors.
Turns out that several member of the FOMC are (correctly!) worried about the Fed’s massive bond intervention.
They’re scared about causing massive inflation. They’re worried about encouraging reckless risk-taking by investors. And they’re frightened about the Fed’s financial stability if bonds collapse. (After all, the Fed is one of the nation’s largest bond owners now.)
These concerns are all 100% justified.
So, these members want to “slow or stop” the Fed’s bond purchases “well before the end of 2013.” One member even wants to stop purchases immediately.
This was a complete shock. Just a couple of weeks ago, Fed officials were hinting that not only would QE 3 (the Fed’s current intervention) continue through 2013, but QE 4 might be coming along too.
Or so it seemed.
Either Fed officials have changed their minds since then, or we misunderstood what they said. Doesn’t matter.
What does matter is that the Fed is single-handedly keeping the Treasury market afloat. When they pull their support... the market for US debt could implode overnight.
And we’re still not done discussing the major threats to bonds. There’s also...
Threat #3: Investors Might Dump Treasuries on Their Own
A Treasury bond is an “IOU” from the United States. Its value is a pure reflection of our government’s ability to repay its debts.
Now consider that:
Consider too that since President Obama first took office, US debt has skyrocketed from $10 trillion to more than $16 trillion.
That’s a 60 percent increase in just four years.
Would you want to lend your wealth to a nation that’s doing this?
Few if any investors are buying Treasuries today because they’re eager to lend to the United States. Instead, the US is benefiting from a flight to (perceived) safety.
Basically, Treasuries look attractive compared to the alternatives. (Think: bonds from Greece, Spain, Italy...)
But that doesn’t give the United States a blank check to do whatever it wants. Blowout spending, the incompetence of Congress, debt skyrocketing 60 percent in just four years... pretty soon, the world will wake up to the scale of the disaster that Washington is building.
Surely, nobody will want to lend to our government at a measly 2.5 percent interest anymore. So it would be wise to ask this question...
What will happen when interest rates actually start to reflect the true financial condition of the United States?
For one thing, our finances will dive even further into the septic tank.
The higher rates go, the more interest the US government must pay. If rates merely go to 5 percent—which is still quite low, historically—the US will pay an additional $250 billion each year in interest.
That’s a quarter of a trillion dollars.
If rates return to the levels of previous financial crises—for example, like the early 1980s—the US will pay an additional $1.5 trillion in interest alone each year.
And then there’s the broader fallout to consider. Treasuries don’t exist in a vacuum—they’re one part of a broader bond market. If Treasuries blow up, we could see...
The Collapse of an Entire Asset Class
With interest rates at historic lows, bond investors are horribly vulnerable to even small upticks in rates.
As an example, the iShares Barclays 20 Year Treasury Bond ETF fell by 2.9 percent last month.
At that time, annual average yields for 20-year Treasuries were about 2.45 percent.
In other words, yields for the entire year were wiped out in just one month.
‘So cry me a river’, you might be thinking. After all, bond investors made big profits as rates fell continuously over the last few years.
If they lose money now, it’s no big deal. Right?
It’s true that bonds have performed very well as rates have fallen. (In fact, they’ve done so well that some think there’s a bubble in the bond market today.)
But it’s not true that all bond investors are wealthy fat cats who can take a haircut in the markets without being affected.
Bonds are a very conservative investment. That’s why large financial institutions make up a large part of the bond market.
We’re talking about pension funds. Mutual funds. Banks. Insurance companies.
Notice also that many of these institutions took huge losses during the 2007/2008 financial crash. Bond profits are the only thing keeping many of them afloat.
If rates rise significantly, these institutions will get pounded. There will be shock waves throughout the economy. We could see large financial institutions folding en masse.
We could also see large investors and institutions looking to move large amounts of capital out of bonds. More on this in a moment.
How to Prepare For What’s Coming in 2013
Obviously, we can’t predict the future. So there’s uncertainty about what’s ahead. Nevertheless, we can and should prepare for the major trends we see forming.
More than ever, it’s crucial that we anticipate the investing climate that’s in our future. In chaotic times, there are always big opportunities. And times have rarely been so chaotic as they are now.
So here are...
Three Paths to Big Profits in 2013
Path #1: Our GEA Strategies
I predict Washington will spend a large part of the year fighting over the national debt and budget.
Yes, it doesn’t take a genius to see this will happen.
But let’s look at the implications. What happens when Republicans and Democrats are at each other’s throats?
What happens when both sides refuse to compromise?
What happens when there’s a looming deadline (like the fiscal cliff, or the debt ceiling, or something else) rushing toward us?
Everybody panics. Stocks and other markets get whacked.
And what happens when a last-minute agreement is finally reached?
Everybody cheers. The markets leap upward in ‘relief rallies’.
In 2013, we’ll probably see several waves of this cycle:
Our GEA options strategies can get explosive results in an environment like this. But we’ll have to be nimble.
We’ll also have to accept that trading is riskier when markets are swinging wildly. Options are time-dependent, and a swing might go against us for long enough to turn some of our trades into losses.
On the other hand, large swings can make our winners spectacularly profitable, and far outweigh the losers.
So I expect us to be very successful overall. Just be aware that not every trade will be a winner.
Lastly, we’ll also have to ignore the emotions that will be driving the markets during these times. That’s more important—and more difficult—than it might sound.
Among my team here at GEA, we have almost a century’s worth of collective trading experience. We’re used to trading against the emotional swings that drive the markets. This is when big money can be made.
When all the talking heads in the media are panicking, and stocks are selling at steep discounts, that’s the time to buy with both hands. Conversely, when everybody else is cheering, that’s the time to sell.
Of course, in both situations that’s the exact opposite of what your emotions will tell you to do.
And that’s why investors who can’t conquer their emotions will never be very successful.
Here in GEA we’ll help you ignore your emotions, and make objective, high-potential trades. We plan to take full advantage of market swings.
Path #2 to Big Profits: Precious Metals
As I said earlier, bonds are normally one of the most conservative investments.
Today, bond investors are getting increasingly nervous. As we’ve seen in this issue, the bond market is becoming a very dangerous place.
So where can investors who need conservative, rock-solid assets invest their money?
If US bonds tank, into which investment categories will all that capital flee?
(Remember, there’s a huge amount of money in play here. US bonds alone are a $37 trillion market.)
A powerful answer recently came from (of all places) the US government.
We recently saw Washington buzzing about an unusual proposal: to sidestep the debt-ceiling issue by minting a $1 trillion platinum coin, and depositing it with the Fed.
Despite the endorsement of some noted figures, it was obviously a silly idea.
Nevertheless, it shows how precious metals are still known as the ultimate stores of value.
It’s ironic, really. Government officials scoff at gold, silver, and platinum. They say these historic stores of wealth are just “barbarous relics.”
But they still flee to precious metals when the dollar threatens to revert to its inherent value. (How much does a rectangle of green paper cost, anyway?)
True, the trillion-dollar coin was just talk. But the US government is starting to officially recognize gold’s inherent value and rock-solid stability.
We also see this in some changes that were quietly made in the banking industry this month...
US Banks Can Now Use Gold to Underwrite Their Operations
Effective this month, regulators have changed the rules about the value of collateral held by banks.
The new rules were a joint decision by the Federal Reserve, the US Department of the Treasury, and the FDIC. The announcement said this:
“In this NPR [notice of proposed rulemaking], the agencies propose to apply the following risk weights for exposures... 1) A zero percent risk weight to cash owned and held in all of a banking organization’s offices or in transit; gold bullion held in the banking organization’s own vaults, or held in another depository institution’s vaults on an allocated basis...”
In other words, according to the US government, gold bullion is now treated the same as cash, with “zero percent risk.”
If even one percent of US bond investors agreed with this assessment, and the bond market took a big hit, we could see $370 billion flood into gold. That’s more than twice the value of all gold mined last year.
Owning even a small amount of gold bullion would make you into a very wealthy person, practically overnight.
But even if we ignore the bond market, this development is still great news for gold. Banks are much more likely to hold gold now. This will be an additional source of demand for the yellow metal.
Also, gold’s value is getting official recognition—an endorsement from the highest possible authorities.
Now combine this with rising demand from other sources (especially China), and tight supplies, and gold should do very well this year.
I’m not the only one who sees this. Economist and author Dr. Stephen Leeb recently said:
“Everyone should own physical gold and silver... For people who are discouraged in gold or mining shares, don’t be. Your day is coming.
“I care about this country and the people that live here. When you see money being printed like tissue paper, you know most bond certificates are going to be used to burn wood and keep houses warm...
“Gold is heading to $10,000 with or without people reading this. Gold and silver are really the de facto currencies in today’s world and they will be the leaders going forward, not paper assets.”
I think this is a great time to stock up on gold. I’m very excited about its potential today.
Path #3 to Big Profits: The Right Stock Trades
This is best illustrated with a real-life example from earlier this month.
On January 3rd, some of my readers received a recommendation to buy the February $65 calls in Norfolk Southern (a railroad company), stock symbol NSC.
Why? Because one of my colleagues was driving cross-country with his family, to visit his wife’s relatives for Christmas.
Along the way, he noticed that many major rivers (the Arkansas, Missouri, Oklahoma and Rio Grande) were down so far that they looked like “creeks.” The Mississippi wasn’t a creek, but was a shadow of its former self.
Then he saw an NBC Nightly News report about the Mississippi, and how tugboats are finding parts of it too low to travel.
My colleague thought: What are the implications of this? In his words:
“I realized that I had my catalyst to take the knowledge of the river levels and make money off it. How?
“One of the key cargo items on barges in the Mississippi is coal. If the barges stop, then that means... coal will need to be moved around by truck or rail cars. The best solution is rail cars.
“The average barge holds cargo that fills 15 rail cars or 60 trucks. The average tugboat can push 16 barges. That means 240 railcars or 960 trucks to replace the barge traffic.
“The coal stocks have been pounded on the belief that the coal industry is dead and Obama hates coal. Therefore, rail stocks that transport coal have been hit and now we have the catalyst to move them off their lows.
“I am sure analysts are becoming aware of this issue but it takes them time to act and we can move much quicker. I fully expect Jim Cramer to pick up on this in the next week and then the floodgates open for these stocks.
“Now this idea is not a pure energy play but coal is the catalyst and we are playing on how it is delivered.”
At that point, he issued his recommendation to buy 20 contracts of the Norfolk Southern calls, which were selling for $100 per contract.
The very next day—almost exactly 24 hours later—he issued a sell recommendation. The markets had realized the same thing he did, and NSC had gone crazy. Each contract had shot up to $180.
Readers who took his advice made an 80 percent profit (before commissions and fees) in just one day.
Then on January 7, he did it again. NSC went down temporarily, and he issued a buy recommendation at $140 per contract. The next day, when it jumped back up, he issued a sell recommendation at $170.
Readers who took his advice made 21.4 percent in less than one day (about 21 hours between recommendations).
Later on January 8, he recommended a call/put spread on Monsanto. The next day (January 9), he closed it.
Readers who took his advice made 54.37 percent (before commissions) in about 26 hours.
By this point, you might be wondering why you don’t remember getting these recommendations in the Gold & Energy Advisor Updates.
That’s because they came from GEA’s sister service, Gold & Energy Options Trader (GEOT).
The trades I just described to you are real examples of the trade recommendations that GEOT members receive as part of their membership.
To be clear, this was an unusual run. Cumulative gains of 155.77 percent in a total of about 71 hours are obviously rare.
Nevertheless, these results aren’t unusual for GEOT:
Even in a bad market, there will always be some trades with crazy potential. And the potential gets even better when markets get emotional—which they’re very likely to do this year, thanks to Washington making a continual mess of things.
The challenge, of course, is discovering these trades.
In GEOT, my colleagues and I have created a system that systematically sifts through the market and finds the highest-potential trades. Not every trade is a winner, of course. But most of them are. And most of the winners are spectacular successes.
I recently created a video explaining how GEOT works. The results are even better now than they were when I made the video (GEOT’s track record has now grown to a total return of 4,683 percent in 64 months), but the rest of the video is still valid.
If you’d like to get GEOT’s results in your own trading, here's the link for the video:
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