Faber and Schiff: Bond bubble trouble

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This post is a guest contribution by Dian Chu, market analyst, trader and author of the Economic Forecasts and Opinions blog.

As I’ve been saying for some time that the bond market is screaming for an imminent burst,  Dr. Marc Faber and Mr. Peter Schiff also spoke with CNBC on August 23 warning of a bond bubble trouble.

Faber – Stay away from a 19-year rally
Faber advises investors to “stay away from Treasuries as they’ve been rallying since 1981–equivalent to a 19-year bull run”–when the 10-year bottomed out on Sep. 21, 1981. Faber says Dec. 18, 2008 was the peak of the bond bubble with yields of 2.08% and 2.53% on the 10-year and 30-year respectively. (See 10-year chart)

“I think  there isn’t much upside potential in Treasuries unless it’s for the short term. Even the short term is uncertain. But if I look 10 years ahead, where do I want to have my money? Certainly not in U.S. Treasuries.”

Faber’s biggest concern is that because of a weak economy, the U.S. budget deficit will likely remain high, and continue to go up under the Obama administration, which could make interest payments on government debt unbearable.

He also warned against the misguided confidence arising from still strong foreign demand for U.S. Treasuries:

“In 1999 and 2000, foreigners (bought) the NASDAQ and what happened afterwards was a major collapse. I would not look at foreign buying as a very intelligent leading indicator.”

Faber says a better place for investor’s money now is farm land and, agricultural commodities, and gold should also be a part of an investor’s portfolio.

Schiff – The mother of all bubbles
Schiff basically declares the bond market the mother of all bubbles, and notes that when the bubble bursts, the loss will dwarf the combined losses of the bubbles of the stock market and  real estate. Eventually, the government will either inflate or default. Either way will ultimately make bond investors go bust.

For risk-averse investors, Schiff believes gold and foreign bonds such as Switzerland where government debt level is not as high, would be better options than U.S. treasuries.

My thoughts
Dismal economic data have spooked investors flocking to Treasuries, driving down yields. Traditionally, bonds are considered to be safer and less volatile than equities and commodities. However, the financial markets have evolved in such a way that the same players are active in all sectors, employing the same trading technique. This, in part, has made bonds behave almost like stocks with similar volatility. (See comparison chart.)

So, investors should start looking at bonds the same way as equities and commodities, and now is the time to move out of bonds and into either equities (dividend-paying blue chips as noted in my previous post), or commodities such as gold.

And for the highly risk averse, parking in cash for the short term would still be better  than staying in “the mother of all bubbles”.

(Recommended Reading: Self-fulfilling Prophecy: The Bond Trade, Yield: Dow 30 vs. 10-year U.S. Treasury, and Bonds & Equities: Expect a Major Shift)

Video Source: CNBC

Source: Dian Chu, Economic Forecasts & Opinions, August 25, 2010.

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5 comments to Faber and Schiff: Bond bubble trouble

  • While I am fully aware of the risks of owning long duration bonds in an inflationary market, the claims that an inflationary series of rates hikes will “bust” bond owners. This is an exaggeration. Last time I checked (unless you believe SCHIFF) high quality bonds return, over time interest payments and original capital. That’s 100% of captial and about 25% return (on a 10 year) NOT like Internet stocks which from highs returned less than 20% of orginal capital. I’ll take 125% return on my capital over 20% any day. I’ll will also hedge my portfolio, acknowleging the risk, but… I won’t buy into “Chicken Little” analysis.

  • It seems to me that we are being ‘conned’ into a set of expectations that go like this: every time the stock market goes down, the US dollar then rises, yields decline, commodities weaken, and even gold has problems hanging in (look at the lows in 2008-9). These are unnatural relationships! So…it cannot be all that long before they change back to their usual relationships – and that’s when the fun will start.

  • Robert Shiller, author of Irrational Exuberance, told the Wall Street Journal that he doesn’t think the bond market is a proper bubble. The distinction he drew about 18 minutes into a video interview, was that typically bubbles are driven by people attracted by past price increases, who expect future price increases. Whereas today Treasuries are more a flight to safety and quality than a bet on rising value.
    I wonder if that makes a difference to the pop? Will those investors be less likely to bail out?

  • Jan Noack

    I think they will bail out much later than expected. Choosing between stashing cash in your magttress and risking fire and theft or the security of storing your money in the bank(or US treasury)..how much return do you wnt? Zero? would you pay for that security.. say 0.5%, could bonds go negative 0.5? say?

  • […] bonds may not be much use as a flight to safety either, argues Prieur du Plessis in a piece up today. Du Plessis makes the interesting argument that anyone investing in Treasuries as a haven […]

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