March 10, 2009 / 6:55 PM / 10 years ago

Select few score big as Treasuries decline

NEW YORK (Reuters) - The brutal drop in Treasury prices so far this year has left a select few with a small fortune.

An employee of the Korea Exchange Bank counts one hundred dollar notes at the bank's headquarters in Seoul February 24, 2009. REUTERS/Jo Yong-Hak

Marc Faber, Doug Kass, David Einhorn and Tom Sowanick are some of the most prominent investors who had been or are betting on lower prices and higher yields on Treasury securities even as the U.S. economy continues to show signs of deterioration.

Fears that the U.S. government will be forced to issue $2 trillion, and possibly more, of Treasuries over the next 12 months to finance rescue packages for the battered banking sector is stoking bets that mounting supply will set in motion a huge domino effect.

Even the flight-to-quality trade into Treasuries, which have been investors’ favorite safe haven during times of turmoil, has been overwhelmed by supply issues, as is the case with Tuesday’s record $34 billion three-year auction.

“Fiscal deficits will be huge as far as the eye can see,” Faber, one of the world’s most closely watched investors, said in an interview. “Government debt will increase significantly. The federal-funds rate is zero. One day, whenever that will be, the economy will recover and inflationary pressures will manifest themselves,” he added.

Markets have wasted no time sniffing out these issues.

Dramatic price drops in long-dated Treasuries have pushed yields to 3.67 percent, roughly 100 basis points higher year-to-date.

Treasuries maturing in 20 years and beyond are posting negative returns of more than 12.5 percent, while Treasuries maturing in 10 to 20 years are down roughly 5.5 percent, according to Barclays Capital.

In his January letter to clients, Einhorn, the president of hedge fund Greenlight Capital, said he was buying calls on higher U.S. long-term interest rates. “The size of the Fed’s balance sheet is exploding and the currency is being debased,” Einhorn said. Consequently, inflation will rear its ugly head in several years and gold along with calls on higher rates will perform well, he said.

Yet some of the most well-known money managers, including Van Hoisington, continue to buy long-dated Treasuries.

Money managers like Hoisington, whose flagship Wasatch-Hoisington U.S. Treasury Fund returned about 38 percent last year, believe the rise in yields won’t hold.

“We don’t expect any uptick to last very long simply because the economy cannot withstand higher interest rates,” Hoisington said in an interview. “The economy is very fragile and we are still going down — the economy is still sinking.”

Hoisington, president of Hoisington Management, which oversees $5.8 billion in assets, said he had been buying 30-year Treasuries at 3.70 percent with new money.

“We think people should be buying long-term Treasuries at 3.60, 3.70 or 3.80” percent, he said. “Any new money we get in, we buy the long stuff. We think as an investor those levels are great buying opportunities.”

Hoisington’s fund, which beat all of its peers last year, is down 12.08 percent so far this year, according to Lipper data.

‘MAJOR BOND BEAR MARKET’

But some investors remain adamant bears, believing that recent price drops and rises in yields will be extended.

“I have covered my shorts because the long Treasuries dropped 20 percent from the December 21 peak, but I look to short again on a rebound in bond prices,” Faber said.

Faber, who advised investors to buy gold eight years ago when it was $300 an ounce, is the author of “The Gloom, Boom & Doom Report.”

“Long term, I think we are at the beginning of a major bond bear market,” he said.

Sowanick, the chief investment officer for $22 billion in assets at Clearbrook Financial LLC, in Princeton, New Jersey, said shorting Treasuries is a good long-term trade.

Since the start of the year, Sowanick has been invested in the ProShares UltraShort 20+ Year Treasury, an exchange-traded fund that gains when long-term Treasury bonds fall. That ETF is up over 30 percent so far this year.

The ETF offers leverage, which magnifies returns when long-term bonds drop as they have.

“I don’t think it is dangerous at all to be shorting Treasuries with all the supply coming,” Sowanick said.

Kass, president of Seabreeze Partners Management, had been shorting the exchange-traded fund iShares Lehman 20+Year Treasury Index since late last year, but is now booking profits. The TLT is down more than 16 percent so far this year.

Kass said even if the Federal Reserve has signaled that it is prepared to buy longer-term Treasury bonds if need be, it made no firm commitment. “People say never fight the Fed. But I say forget the Fed. I don’t think they will go there.”

Editing by Leslie Adler

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