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Posted January 5, 2005

Even though there are four or five other markets in which I am currently interested, this is the one which has my immediate attention. This is a trade that goes against everything you hear from anybody who supposedly knows anything about the direction of interest rates.

I think the Treasury Bond market is about to move sharply higher, meaning long term rates will be turning sharply lower. I am therefore a buyer in the bond market looking for something like a 10 point run ($10,000 per futures contract) to begin with.

I have vowed to be brief in what I write this year so here are the nuts and bolts...

The Fed has been raising short term rates since June. EVERYONE looked for Bonds to fall, but they finished the rest of the year pushing new highs.

The Dollar has been falling for several years now, which lately has inspired lots of commentary that foreigners are going to stop buying our paper, or, in fact, start selling it, which would mean Bonds going in the tank (and long term rates much higher)...but Bonds finished the year still pushing new highs.

Inflation has been on the rise all year, which is supposed to push Bond prices down, but Bonds finished the year pushing new highs.

The economy has been expanding all year, supposedly bearish for Bonds, but Bonds finished the year pushing new highs.

Although the numbers are not stellar, job growth has resumed, but bonds finished the year pushing new highs.

Stocks and Bonds have been moving opposite each other for some 4-5 years now, but even with the sharp year end rally in Stocks, Bonds finished the year pushing new highs.

The governement deficit seems to be growing uncontrollably, supposedly bearish for Bonds, but Bonds finished the year pushing new highs.

We experienced an enourmous bull market in Energy prices this year, which traditionally is bearish for Bonds, as high energy prices may lead to inflation, but Bonds finished the year pushing new highs.

Even when Crude hit the $50.00's and the traditional Oil vs. Bonds argument ws reversed to then consider high energy prices as a tax on the consumer (supposedly slowing the economy and bullish for Bond prices)....and Crude then dropped $15.00 a barrel, which "should have" pushed Bonds down? Even then, Bonds finished the year, yes, pushing new highs.

I think that is enough. All of the factors above (apologies for all the repetition) have been touted as reasons why bonds should have been going down, and they haven't, so what's next? If, in spite of all these events that are supposedly bearish for Bonds, Bonds are on their highs, what do you suppose will happen when we get some bullish news? Or have just exhausted all the "bearish" news/events?

I am very bullish this market. While I am initiating this trade looking for 10 points or so, seeing the move be much bigger than that would not surprise me at all.

Very briefly, I think the analytic community can talk up the idea of a decline in Bond prices (and rise in long term yields) all they want, but the simple fact is people who actually own Bonds are not really interested in selling them. My mother, for example, owns Treasuries  bought maybe 8-10 years ago paying about 7.5% a year that still have 15 years to go. If she sells them, what does she do with the money to replace that income?....As I have said for some time now, I believe the demographics of the Baby Boom (approaching retirement) mean that more and more of retirement accounts will be selecting fixed income investments (however "low" might be the perception of yield), which means a steady influx of buyers somewhat similar to what the Stock Market experienced in the 1990's. When you actually buy a 20 year instrument, this is generally not a short term trade, i.e., not something you are going to sell in one or two years....This may be simplistic, but in the real world ( as opposed to the analytic community), I think the equation of no actual sellers and a steady influx of new buyers argues for Bond prices to go higher, and long rates lower, for some time to come.

And this stuff about foreigners dumping our paper as the Dollar falls? With our Dollar having dropped more than 25% during the last few years, not only does it mean anything American might be considered to be at a 25% discount, but it also means you are buying in a currency that possibly has more upside potential than down.....As Alan Greenspan himself has stated several times the last few years, "Statistics have shown that forecasting exchange rates has a success rate no better than forecasting the outcome of a coin toss." In other words, when EVERYBODY is on one side of the table, as in absolutely sure nothing will turn the Dollar around, and Greeenspan himself says, "Nobody knows!", it seems like the most classic contrarian play there is. The Dollar may surprise everyone on the upside this year....but that's another story....Bottom line to me is, the Dollar being where it is is bullish for Bonds , not bearish.

I don't know if that was brief, but it's as short as I could get it. Believe me, I think there are many more reasons why we are not at the lows in Long Term Interest Rates, nor the highs in Treasury Bond prices.

Here are the charts and some numbers.....

1-5-05bond monthly.gif (10347 bytes)

1-5-05marchbonds.gif (14817 bytes)

1-5-05june05bond.gif (13341 bytes)

For the sake of tracking my recommendations, we will use tomorrow morning's opening in June Bonds as the purchase price of one futures contract. We will use the opening in options as the purchase price of one June 111 put. Those prices will be posted here at some point tomorrow. (Posted January 6, 2005---Bought 1 June Bond at 111 06 and 1 June 111 Put at 2 23/64.)

Give me a call and let's talk about this....Just tell me how much you want to risk and I will give you the different approaches you might take. I may end up being wrong but many of you have seen just this same setup in Bonds with me over the years.

Bill Rhyne



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