The next big shoe to drop and giant bubble to pop is the US bond market. The explosive run up into December 2008 was an absolute Christmas present for bond bears willing to short the panic top. The 2008 fear-related spike in bonds was the equivalent to NASDAQ in 2000 or real estate in 2004. However, this explosive move up was primarily driven by global fear, where the other two bubbles were driven by greed.

Another opportunity to get short in bonds is upon us. Using technical analysis, it appears that the run up in bonds last December was the head of a giant head-and-shoulders top on the weekly charts. I wouldn't advise anyone to short bond weakness but instead to short failed rallies into resistance. Bonds don’t end their seasonally strongest period until late November, and there seem to be plenty of eager buyers around at auction time. In spite of this fact, I do expect bonds to complete this huge head-and-shoulders top between now and Thanksgiving. The long secular bull market in bonds ended in December 2008 and a new secular bear market in bonds has only just begun.

As the US government continues to waste money bailing out failed enterprises, failed business practices, and Wall Street investment banks, they're rapidly adding to an enormous mountain of debt. The government is flooding the market with a record monthly supply of new Treasuries to fund our irresponsible ways as a nation. Surprisingly, central banks continue to aggressively buy a record amount of bonds at what I perceive to be the top, just as they sold record amounts of gold at its bottom, now nearly a decade ago. Central banks buying bonds today will be a regretful act comparable to that of central banks selling gold at $250-$350 per ounce.

There's a growing confidence that the Fed will continue to purchase bonds with an unending bid coupled with the promise of keeping short-term rates low for the foreseeable future. Individual investors have pumped record amounts of cash into bond mutual funds this year, just like they did in stock funds in 1999. I believe that with the first rumor of a failed Treasury auction, investors will finally flee bonds in droves. The monthly record supply of bonds and the coming decline in demand is all that's needed to spell disaster for the bond market. (The TBT ETF is a great way to play the coming bear market in bonds.)

Inflate or Deflate?

As the Federal Reserve prints money and monetizes our debt, they're giving politicians in Washington a green light to spend our country into financial ruin. In my opinion, Ben Bernanke will be treated by history just as his predecessor Alan Greenspan will be treated. Ultimately, both will be totally discredited after having been praised as heroes for saving the world from economic collapse. Until Mr. Bernanke stops monetizing US debt, and hikes rates to protect the US dollar, he's literally sending this message to every bond trader: "Sell us bonds now."

Bond traders are responding to this message in 2009 by selling the long end of the yield curve with growing confidence, believing that there will continue to be enormous volume of bonds issued with increasing rates. In my recently published book, Discover the Upside of Down, I describe in detail how Ben Bernanke, along with his boss, the Congress of the United States, will cause interest rates to rise, and the country to enter into a new era of stagflation. At this time, dollars in America are being destroyed through debt repudiation as fast as they're being created by the Fed. This is the deflation battle the Fed has been fighting and losing. However, if the US government successfully bails out the world and the economy truly recovers, look out above on interest rates and inflation. The message that a rising gold price is giving us, is to get ready for massive inflation or for a US government debt default. What's currently taking place is that the Fed is trying to hold a basketball (interest rates) under water; the minute they let go, the ball (rates) will explode higher. That’s what will happen in 2010 once the bond market traders pull Chairman Bernanke's arms behind his back.

Mr. Bernanke is going to have to make a decision soon between sacrificing the stock market or the bond market. If he allows stocks to continue to rise on the promise of zero rates for an "extended period," then he risks rapidly rising interest rates when the Fed finally allows bonds to react to market forces instead of the Fed's monetization efforts. He'll have to try to save bonds by sacrificing stocks, or risk the US empire’s ability to finance its massive debt obligations. However, the Fed alone can’t hold up the weight of the world. If central banks suddenly demand higher rates due to a rising perceived risk of a coming default, bonds will crumble no matter what actions the Fed may take.

As you'll soon see, the power of compound interest works both ways. As time goes on, our debt burden continues to grow from compound interest on trillions of dollars in debt. As interest rates rise, the government will have to raise money at higher and higher rates, making our enormous debt burden increase to the size of Mount St. Helens, ripe for a volcanic explosion. Should that explosion occur, our country's economy will be destroyed. The gold bugs are guessing the Fed won’t get it until it’s too late; that the message is being delivered by rising gold prices.

Go visit the US debt clock website and ask yourself how it would be possible for the United States government to ever pay back such an enormous amount of debt. They can't, and many (including me) believe that they won't. At some point in time, the whole world will look at the unimaginable debt levels the United States has accumulated and see that all roads lead to default and massive inflation. That’s right, I said default. It’s either that or a continued managed decline in the currency to inflate our way out of this mess. Either way, get out of bonds, and fast, as they are simply another financial bubble being sustained by the Fed.

In summary, this is a vicious cycle taking place. First, there's no political will in this country to cut spending or raise taxes to reduce our massive deficits and obligations. Also, the Federal Reserve is led by a man referred to as "Helicopter Ben," and that's by no means an accident. Next, the Fed is trying to create another paper boom in the stock market through easy money for an "extended period of time." Finally, the rest of the world will attempt to devalue their respective currencies to help their exports. A whole new competitive devaluation process should soon begin. The end result is that smart money will continue to sell and to short bonds globally. This would appear to be a long-term secular shorting opportunity of a lifetime in bonds, and it’s just beginning.

Minyanville is proud to announce it has launched the Grail ETF & Equity Investor newsletter  written by Ron Coby & Denny Lamson using their proprietary Lamson Grail Timing Indicator with a concentration on ETF & equities investing. For more information, and to sign up for a two week trial, click here.

©2008 Minyanville Publishing and Multimedia, LLC. All Rights Reserved.

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