What Kind of Investor is Happy to Lose Money Over 90 Days?

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Your editor departs for Wellington for five days today to meet with an old friend about publishing his newsletter. His letter is a top-down, geopolitical, macro-economic report grounded in an exceptional knowledge of the credit cycle and history in general. We’ll keep you posted.

But there are some strange and perplexing crumbs to collect from news reports this morning. Yesterday we learned that for the first time in 70 years, yields on 90-day U.S. government securities were briefly negative. Investors – if you can call them that – were happy to loan money to the U.S. government for 90 days – and lose money.

Normally, the only thing that could explain such an unusual preference for liquidity at the expense of return is abject terror of equities. But stocks have been moving on up nicely. The plunge in short-term yields can’t be explained in terms of “risk aversion.” So what’s behind it?

It’s a pretty interesting question if you simply phrase it: what kind of investor is happy to lose money over 90 days? Is the move to the short-end of the U.S. yield curve part of a broader shift out of longer-dated maturities (10 year notes and 30-year bonds).

Even the New York Times is starting to freak out about the amount of U.S. debt that must be rolled over in the next four years. The times article points out what we pointed out at the beginning of the month: U.S. debt is far more interest rate sensitive than ever before, which makes it potentially far more expensive to service if interest rates spike.

But that doesn’t get us any closer to explaining the near-zero short-term yields. Granted, they were low to begin with. Maybe they are only unusual because they descended from such a low base to begin with. But is there another explanation that sheds light on what’s going on in the markets?

One possibility, and we admit we are speculating here, is that banks are beefing up on liquid assets to bolster their capital positions. Whether this action corresponds with the end of the year or some other force, well, we have no idea. But without a corresponding fall in some other asset, the fall in short-term bond yields must represent a preference by institutions for T-bills and notes right now.

Our colleague Kris Sayce thinks institutions might be using T-Bills as collateral for other loans, pyramiding their way up to new balance sheet growth. It’s possible. It’s also possible that banks are buffering their capital positions in anticipation of…turbulence.

In today’s Age, Eric Johnston begins his story with the headline, “Australian banks fail new capital test.” Gee, that sounds familiar! “Ratings agency Standard & Poor’s has warned that nearly all the world’s big banks – including Australia’s major lenders – have insufficient funds to cover their lending exposures and risk a ratings downgrade unless they move to bolster their balance sheets over the next 18 months.’

That might sound odd, considering that Aussie banks tapped equity markets for $20 billion in new equity last year. But did the new money actually bolster the balance sheet? Johnston reports that, “While Australian banks benefited from having a large exposure to low-risk residential mortgages, S&P said a narrow geographic and business base counted as a negative. It also noted that the capital raisings by the local banks had been used mainly to fund acquisitions or balance sheet growth.”

More home lending baby!

It’s probably a stretch – given we have no evidence whatsoever – to suggest that global banks (Australia’s included) are bolstering capital by moving into short-term U.S. debt. It’s also arguable that U.S. debt – even short-term near cash bills and notes – are a quality asset to be adding to your capital mix. But it’s a lead and we’re chasing it down.

Why does it matter? Well, the last time yields went negative like this was in 1938. That preceded a collapse in the stock market and the onset of the “Great” part of the U.S. Depression. Of course in 1938 the Fed began tightening up monetary policy again (prematurely, some argue). It won’t do that today.

Meanwhile, some other troubling pieces of information from the bond market. Bloomberg reports that Telstra, “scrapped a domestic bond sale plan after it couldn’t reach an agreement with investors on the terms of the securities. ” Apparently bondholders “wanted the 10-year debt to include assurances compensating them if Telstra’s credit rating gets downgraded.”

Geez. Creditors are getting pretty choosy these days, aren’t they?

There are other stories we’d like to have a closer look at today. For instance, a Brazilian steel-maker has plans to buy 16.5% of coal explorer Riversdale Mining for $190 million. This fits the pattern we described earlier this week of major international companies seeking to buy independent junior miners in order to guarantee resource supply. We’ll have to ask Dr. Cowie what he thinks.

Time to board the plane now and cross the Tasman. We’ll report tomorrow from the east coast of the North Island. Until then.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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20 Comments on "What Kind of Investor is Happy to Lose Money Over 90 Days?"

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Ross
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There is a sense of trepidation, of waiting, the narrative itself is stale because most has been revealed. I am staying with “select” equities for the same reason that I chose to tilt toward them in early 08. Liquid nta backed equities are better than trashed fiat cash or bills of promises by governments backed only by the very tax collections that are in an accelarating rate of collapse. A couple of quick bucks as the USD does the last dance of the super nova but otherwise I am long.

Ned S
Guest

I genuinely thought you were in the deflationist’s camp for some reason Ross. Was I mistaken?

Justin
Guest
The UST market is by far the largest & most liquid on the planet and has been for many years. Here are some quotes from 1983!; “A huge expansion has occurred in recent years in total Treasury debt outstanding”……….”The sharp increase in Treasury debt has caused a substantial rise in the amount of marketable Treasury securities outstanding. Most of this rise has occurred through increases in the amounts of notes & bills outstanding. Negotiable bonds represent the smallest component of the Treasury’s total marketable debt”………..”The constantly increasing amount of Treasury debt outstanding & the increasing volatility of rates have caused… Read more »
Ned S
Guest
It’s the money based hypocrisy of all this stuff that gets up my nose – China loses another 100 odd workers in a coal mine disaster – And the West goes tut tut – As if the West actually cares what happens to a 100 “chinks”. Way more a matter of them being concerned about the Chinese outcompeting them “methinks”? (Or else they’d be saying Yeh, that killing of 160,000 odd Iraqi citizens we caused over the last few years WAS a bit iffy!) Breaking news: 2 Chinee man get bullet in blain over Tainted milk scandal! (As it reflect… Read more »
watcher7
Guest
The ‘Great’ of the Great Depression? Dan wrote that the Fed “won’t do that today” – that is raise interest rate prematurely. The Fed is doing something even worse – holding down interest rates enabling the Government-Finance Bubble. As in 1931 the Fed will be forced to raise interest rates, not to maintain the gold standard, but to contain inflation in the present ‘fiat monetary system’. That will be the signal that the “Great” phase of the global financial crisis is near. (Andrew Mellon’s advice to Hoover was the correct advice). “By the summer of 1931 … the United States… Read more »
Justin
Guest
“permitted government securities to be substituted for gold as collateral for Federal Reserve notes, above the minimum of 40 percent. This made it possible for the Reserve Banks to increase open-market purchases and pump new funds into the market, but the flood of bank failures continued” I don’t think the situation is so different now. The Fed & the RBA now collateralise their credit with not just government securities but all kinds of worthless bank paper MBS, BA’s etc. Yet just as banks continued to fail in 1932 because depositors demanded their deposits in gold (as written on the banknote)… Read more »
Justin
Guest
I’ve also read that the real trigger for the Great Depression was the devaluation of the pound in 1931, actually the British government defaulting on its obligation to redeem its banknotes in gold, as written on the banknote. I have a neat picture of the scene outside the BofE when devaluation was announced, panic among the pin striped suits & bowler hats! Up until this time most global trade was financed by bills of exchange, denominated in Pounds Sterling, cleared through London. Upon devaluation, 30% in one day!, these bills could no longer be cleared, so world trade ground to… Read more »
Ross
Guest
Ned, deflation first with a rapid deleveraging and short covering, then inflation to shortly thereafter follow. In the Weimar era there were those that rode both ‘flations at different times. As Prozac says velocity counts, there are many that discount it, but they are wrong. Right now all that liquidity is not enough, only half the RMBS and even less of the REIT has been accounted and 80% or more of the liquidity is stuck in dud balance sheets of both govt and banks or released into the carry. In the US we are looking at a 7 trillion hole… Read more »
Ned S
Guest

Thanks Ross – Much appreciatted!

Dan
Guest

Justin, perhaps, for the owners of gold, this run on gold (which arguably is occurring now) is an opportunity to gradually offload the shiny stuff for profit and convert it into the trade of the next decade (what could that be I wonder?). Perhaps it’s a little early, perhaps they should do it into next year and 2011.

Lachlan Scanlan
Guest

Silver barely started to move yet but its gonna be big when she blows.

Joe
Guest

http://en.wikipedia.org/wiki/Executive_Order_6102

I’ll be back as one prominent californian governor used to say.

Be wary.

Dan
Guest

Didn’t say anything about hoarding gold plated tungsten though, Joe.

Lachlan Scanlan
Guest

Not likley Joe. A Obama will just start war or step up an existing war to save the day. Hes already talking about a war tax to fund the Mid East misadventure.
I wonder if the tungsten thing was for real or just urban myth?

Justin
Guest

Dan, I’ve heard from someone more knowledgeable than I that the time to trade your gold, for stocks at least, is when the S&P is worth half an ounce of it, still a ways to go yet.

Gerry
Guest
Gold fever…..always with the human spirit in some form and certainly good reasons for it being with us now. Just a timely warning from one who has seen previous gold scams…no they don’t salt mines much these days…don’t have to, as in a gold rush these days they only have to sell you a piece of paper saying you own gold, and that piece of paper is as valuable as the amount of gold it says you “own”. Used to least have to see the gold mine and be tricked. My humble contribution to this site is to caution that… Read more »
Dan
Guest
Agreed, Gerry. I think if you invest in an economically active entity then you are taking a much smaller risk. I mean, a city house on 500sqm land, paid off and rented out generates about as much rent as, well, a city house on 500sqm land, and is worth about the same as any other such house generating the same rent (forgive the tautology). Compare this to gold. Who cares if house prices halve or double, because in the end you aren’t worried about the price but the value. Because more than likely if you have adjusted your lifestyle (by… Read more »
christina
Guest

Gosh, you can sure see why that saying from the Great depression came about: “If you don’t hold it, you don’t own it”

Another Dan
Guest
Dan, I worry that you have missed the point entirely of Gerry’s comment, he is merely warning that the value of paper gold is subject to fraud and manipulation, he does not question the value of physical gold. I agree with you that rental income from a house that is wholly owned is a safe way to provide an alternative income. However consider that a 5% yield on property, (probably 3% after tax) is the same rate that you can get on a 5 yr goverment bond, or less than 6% which you can get on a 2 yr term… Read more »
Dan
Guest

Yeah, ok, good point :)

wpDiscuz
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