Treasuries Are The Key

Treasuries Are The Key In 2009
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By Jordan Roy-Byrne | 10 January 2009

In 2008, the market that was the trigger for other markets was the currency market. The bottom in the dollar led to a peak in commodities and helped spur massive deleveraging and selling of various holdings. For certain, the increasing strength of the Yen also caused great damage to the global economy and global capital markets. There were only a handful of places to hide, free of volatility and immediate risk. Either you owned government bonds, the dollar or the yen. Gold advanced in 2008, though with extreme volatility compared to other safe-havens.

We believe that 2009 will be similar to 2008 in that a particular market will affect all other markets. As we showed in the Market Outlook, Treasuries are very likely to be the key market and that also includes foreign government bonds (of the largest nations). There is a reason and it's simple. In a deflationary environment money moves to the safety of government bonds. Governments swell in size (both literally and figuratively) to help the economy fight deflation, which cripples the private sector. A recovery ensues only after money begins exiting government bonds for more productive purposes.

In today's case money will move out of government bonds to seek a real safe haven and to maintain purchasing power and the value of savings. Keep in mind that the US in 1929 and Japan in 1990 maintained surpluses. Few nations today have a current account or budget surplus. Furthermore, exacerbating conditions will make it even more difficult for the 'creditor' nations to lend to the debtor nations [[think China and their problems! : normxxx]]. The decline in the US trade deficit, commodity prices and economic activity will simply lead to even tighter global liquidity, fewer creditor nations, and ultimately monetization. [[which has already begun in the US: normxxx]]. The crash in oil means that Russian and Arab Treasury purchases will decline drastically [[some projections have the Russians running through their reserves by March!: normxxx]].

The global recession will halt and/or limit Japanese and Chinese Treasury purchases. The massive decline in commodity prices will hurt the accounts of Brazil, Canada and Australia. Furthermore, why would one government lend to other governments in debt when they have their own economic problems to worry about?

In the wake of the crisis, the currencies of weaker nations were and will continue to be hammered. These nations don't have the borrowing power of the US or UK and their debts are often denominated in 'hard' foreign currencies, less likely to depreciate. [[The EU has no Eurobonds, a major weakness that could lead to the dissolution of the EU as rates all over Europe go wild. The spread beween German bunds and Greek bonds is close to 3%— an unimaginable breach.: normxxx]] Hence, printing money would cause immediate hyperinflation in their currencies. In 2009 the borrowing power of the stronger nations is going to run out. Creditor nations will have sharply reduced surpluses and thus a reduced capacity to borrow or lend.

Also, 'citizens' (ie, 'non-government' institutions) can only buy so many government bonds. This is how and when monetization will occur. Budget deficits will bleed red and government bonds will begin to plunge in price (leading to higher yields), reflecting the poor fundamentals and the diminishing capacity for international lending. The larger nations are going to have to monetize [[to keep long term yields down, as in the US, if for no other reason: normxxx]] and that is what will spark the real surge in Gold and Silver [[but probably not while deflation still rages: normxxx]]. Just take a look at these headlines from January 19.

Eurozone budget deficits to soar as economy shrinks
Gilts Tumble on Speculation U.K. Government Borrowing Will Rise
Spain Downgraded by S&P as Slump Swells Budget Gap

Keep in mind that we write with the full 2009 in view. Until government bonds and specifically US Treasuries roll over, deflation will be the order of the day. Be wary however, as the "whip-around" is likely to be quick and nasty. It will be difficult to determine when that turnaround occurs (except, as usual, in hindsight), though we will do our absolute best to spot it! Our thoughts on when this "whip-around" is likely to occur are included in our 2009 Market Outlook. All the best to everyone in 2009!

  M O R E. . .

Normxxx    
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