Be Wary of U.s. Treasury Bonds in 2009. January 2, 2009

If I’m right, as we all know about bubbles, once they burst the decline is almost always an equally abrupt decline back down to normal levels. For bonds that could be a double-digit loss from current levels.

What could be the catalyst for a sharp reversal in U.S. Treasury bonds?

Actually, there are several.

Let’s begin with the stock market rally off its November low. So far the S&P 500 has gained 23% off that low in less than two months. I expect the rally will continue for several more months, possibly even until the beginning of the market’s next ‘unfavorable season’ in April or May, (although I’ll be watching the charts and technical indicators closely).

As I have been pointing out since our buy signal on the market, just a normal bear market rally that retraces 50% of the market’s decline before the downside resumes, would be as much as a 50% rally for the S&P 500. If I’m right, at what point will previously panicked investors, being paid record low yields to hold the bonds, begin to realize the profits they’re losing out on in the stock market, and bail out of bonds just as suddenly as they panicked into them?

Then there is the big increase in the supply of bonds that is likely, as the Treasury has to raise its debt levels to fund the humongous bailout packages. We all know what an increase in supply of anything does to prices.

And then there is the ‘big picture’ worry that has been around for years. When will Japan, China, and other world powers that hold such a high percentage of U.S. bond debt, decide soaring U.S. government debt has become just too risky, and move some of those assets out of U.S. bonds and into other global assets?

It may be too early to take a downside position against bonds right now. Going short a bubble while it’s still rising can be costly, as they can go on longer than anyone anticipates.

But it’s not too early to get ready, by investigating holdings designed to produce profits when bond prices decline.

Among them are the Rydex Inverse Govt Bond Fund, symbol RYJUX, which is designed to go up when 30-year bond prices decline. Then there are a couple of leveraged inverse ETF’s designed to go up twice as fast as the price of bonds decline. They are the ProShares UltraShort Lehman 7-10 year Treasury etf, symbol PST, and the ProShares UltraShort Lehman 20+ year Treasury etf, symbol TBT.

Something to be watching anyway as 2009 gets underway.

Sy Harding publishes the financial website www.StreetSmartReport.com and a free daily Internet blog at www.SyHardingblog.com. In 1999 he authored Riding the Bear – How To Prosper In the Coming Bear Market. His new book is Beat the Market the Easy Way! – Proven Seasonal Strategies Double Market’s Performance!