Understanding the Trade of the Generation

Asset prices continue to fall around the USA and most of the world. Bonds, stocks, real estate, businesses - basically any asset you can think of has fallen in value by 30-50% during the past 12 months.

The only assets that have risen in value quite ironically are US dollars, Japanese Yen, and US Treasury Bonds.

When will asset prices stop falling? When one of the following two things happen:

1) When all of the bad debts are unwound and the borrower obligated on those debts declares bankruptcy or sells at a distressed price to a financially sound counterparty (the proverbial strong hand.)

2) When the government prints enough money so that the amount of dollars in the system increases the overall price level by 100-200% so that wages and prices can support the high structure of debt in the economy and the burden of that debt as percentage of income and GDP falls in real value.

As anticipated and discussed extensively over the past six months, #2 is the favored outcome of our government. So where does this leave us? With the "Trade of the Generation."

Jim Rogers, Bill Cara, Marc Faber, Peter Schiff and several other commentators that I highly respect have explained the trade of the generation concept in great detail, although given their fundamental bias as opposed to trading prowess (exception Cara) - they have been way early and cost themselves and their investors money in the process.

The Trade of the Generation is to sell US Treasury Bonds (10 year) via futures or ETFs and simultaneously go long precious metals (physical gold and silver, futures, ETFs, or mining stocks). The basic analysis behind the play is that the government can and IS creating unlimited amounts of new dollar and treasury bond obligations. Presently the Federal Reserve is monetizing any asset in sight - essentially printing up new dollars to trade with Banks or other financially important "systemic" players for their bad assets. You can argue that the intervention is sterilized as supposedly the Treasury is simultaneously selling off Treasury Bills to fund the money printing but the end result is the same.

During the Weimar Republic hyperinflation in the early 1920s in Germany, the Reichsbank attempted to do the same and the end result was the same - massive massive inflation. One way to think about it is that every 10 trillion of obligations the US government binds us to is equivalent to $40,000 for every man woman and child. If you add up the present value of Medicare, Social Security, Pre-existing Treasury Debt, New Treasury debt we are around $60 billion presently or $240,000 for every citizen. People declare personal bankruptcy over $20-30,000 in debt much less $240,000.

So setting the hyperbole aside - if you had entered the trade of the generation in May of 2008 at the the beginning of the current panic you would have lost 70-80% of your equity already. What does this mean? The deflationary panic we are currently going through has not yet abated and could continue for a longer period of time. How long? 1 month, 6 months, 1 year? It is difficult to know or predict. It tough to know the bottom for gold prices, treasury yields, and the dollar.

I would expect gold prices of $450-500, 10 year treasury note yields of 1-2%, and dollar index value of 100 to be reasonable targets. They would cause maximum pain for traders early to the party and give the Federal Reserve and global policy makers maximum latitude to create a deflationary panic before they fully rev up the printing presses.

What type of returns (unleveraged) will the TOG generate? I expect over a 5 year period that unleveraged returns will be around 10 to 1. Meaning if you sold 10 year treasury notes near the bottom in yields around 1% at the end of 5 years they could yield more than 10%. Gold accumulated near the bottom around $400-500 per ounce could easily appreciate to $5,000 per ounce over a five year period. Leveraged returns will be higher. A reasonable leverage of 5-1 could produce returns closer to 50 to 1 or 5000%.

I will comment more on this as the situation unfolds. We are still early but it is always interesting to discuss where we might be headed.