Buy Bonds for Safety? More Investment Myths Exposed

 


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For many investors, there are only two assets worth considering most of the time - stocks or bonds. “When the stock market falters, switch to bonds for ‘safety. ’ They might be dull and boring, compared to the roller-coaster ride shares can give you, but you can't lose on US Government Bonds, because apart from less volatility, you have the strongest guarantee in the world. " So goes the argument.

Is this true? Are Uncle Sam's Treasuries safe? Well, if you don’t mind lending your hard-earned savings to someone who already owes $9 trillion and has no chance of ever paying it back, I guess you could say they are safe.

Bonds are only safe because people (including international investors, even central banks) think they are safe. When it comes time for Uncle Sam to repay his loans, he simply borrows some more (issues new bonds), often from the same people. The lemmings love them. If that’s not a gigantic Ponzi scheme, what is? If you or I tried it, we’d be behind bars! But the scheme survives because people believe in it, as they do the fractional reserve banking system. .

Just like money in the bank, technically bonds are a very unsafe investment. But whilst ever the public maintains confidence in the confidence trick that both represent, you should not lose too much.

But this brings up the main factor to consider when buying bonds. Creditworthiness is one thing. But the market risk is of even greater concern. And whatever I have to say about Treasuries here is doubled, tripled, quadrupled and more when it comes to junk bonds (lower than investment grade).

Investing is so easy. You only have to remember one rule: Buy when prices are low; Sell when prices are high. It’s that simple. Yet it is human nature to do the opposite. When an asset has been on the bottom for years, nobody wants to touch it. Once it has doubled in price, everybody wants to buy it. Crazy, huh? But that’s why a study of crowd behavior (socionomics and Elliott Wave patterns) is far more important than a study of economic fundamentals.

So, where are bonds now? Like stocks, they are near record high levels (interest rates near record low levels). So what should you be doing – buying or selling? I told you it was simple.

The last time I recommended buying bonds was in 1989, when the yield on the Australian 10-year was 14%. It has since been below 5% and is still below 6%.

Today if you buy 30-year US bonds, you are locking in less then 5% per annum for 30 years. In 1981 you could have locked in 15% per annum. And you could have sold them along the way for a huge capital profit. Yet today they are infinitely more popular than they were in 1981, when bonds were a dirty word. That’s human nature.

“The 13 ¼ percent bond due in 2014 that the government sold on May 15, 1984, returned an annualized 24 percent. The S&P 500 returned 13 percent, including dividends, during the same period. ” Courtesy Bloomberg

Clearly the most important thing is not so much what you buy and sell but when you buy and sell.

The junk bond market is a disaster waiting to happen. With investors desperate to get a better yield, they have been prepared to ignore risk, with the result that the spread between government paper and junk is near a record low. Investors are clamoring for junk yet it is clearly the worst possible time to be doing so. Along with private equity and hedge funds, associated junk bonds are going to be the greatest disaster since the dotcom crash (unless the housing crunch beats it to the punch).

But with countries like China and Japan owning hundreds of billions of dollars worth of US Government paper, is there no risk that panic selling could break out at any time even in the “quality” market, causing a collapse in bond prices and a corresponding escalation in long term interest rates around the world? A persistent inverse yield curve has been warning of trouble ahead for many months. Does the fact that this has been ignored mean that the trouble will not occur?

The expression “flight to safety, " when used in reference to bonds, may really mean “out of the frying pan into the fire. "

The Graham Dyer Newsletter has not missed a month's publication since July 1983. His track record for forecasting is the envy of many, including the 1987 stock market crash, the demise of the Japanese economy and stock and real estate markets in the 1990s, the bull market for bonds from 1989, and the real estate boom this decade. His book is entitled:
“How to Profit from the Coming Great Depression. " If you want to know the pitfalls of investing as well as the opportunities, Graham Dyer’s world class work is a must read. For more of Graham's work you can visit his Blog at grahamdyer.com/blog

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