from CapitalistExploits.at, via Zero Hedge:
Market dislocations occur when financial markets, operating under stressful conditions, experience large widespread asset mispricing.
Welcome to this week’s edition of “World Out Of Whack” where every Wednesday we take time out of our day to laugh, poke fun at and present to you absurdity in global financial markets in all it’s glorious insanity.
While we enjoy a good laugh, the truth is that the first step to protecting ourselves from losses is to protect ourselves from ignorance.
Think of the “World Out Of Whack” as your double thick armour plated side impact protection system in a financial world littered with drunk drivers.
Selfishly we also know that the biggest (and often the fastest) returns come from asymmetric market moves. But, in order to identify these moves we must first identify where they live.
Occasionally we find opportunities where we can buy (or sell) assets for mere cents on the dollar – because, after all, we are capitalists.
In this week’s edition of the WOW we’re covering the relationship between Bonds and Commodities
As our monetary overlords swallow up more and more of the sovereign bond market, punching bonds higher, and kicking yields into negative territory, the inevitable consequences are showing themselves. Bonds are now being traded and priced in much the same way as commodities are.
To be clear: this isn’t “supposed” to happen. When traders buy a bushel of wheat they don’t do so expecting to receive a yield on it. They buy it to sell it at a higher price to the next guy.
Bonds, however, are completely different. Or at least they used to be.
Investors buy bonds (i.e. they lend money) and are then paid a set percentage fee for the lifetime of the loan, and they’re also paid the principal at the end of the loan term. The coupon or yield can be paid monthly, quarterly, annually, or capitalised and paid at maturity. That’s entirely different to a commodity. Also, we know that bonds are typically secured against assets standing ahead of other creditors in the event of liquidation and as such they’re more secure than equity.
Now, I’m not telling you anything you didn’t already know. My apologies for being really simplistic but I do it because when so little makes sense in markets, it’s probably time for us all to go back to basics, bring out the crayons, and ensure that 1 and 1 really does equal 2.
As I write to you today, bonds no longer trade on yield but on some future price.
Let’s for a minute revisit the 2008 global financial crisis.
It’s worth revisiting – for the purposes of understanding – how and why we humans do such stupid stupid things and do them repeatedly.
It’s as if we have marshmallows between our ears. If it was the case for central bankers, we’d all be better off as instead of inflicting such damage to the world economy, they’d instead be found slumped on the sofa, eyes glazed over, and drool running down their chests. Alas there are not enough marshmallows to go around and so instead we get what we get.
As I discussed a couple of months ago, the GFC was birthed in the real estate market.
Now real estate is a yield bearing investment, or at least it should be. So unless you’re buying real estate for your personal use, it is essentially a bond. It has underlying collateral value, and it provides a quantifiable and consistent stream of cashflows.
In a bull market capital chases yield first. It doesn’t chase price appreciation. Price appreciation is simply the consequence of yield chasing since yields decline as more buyers dive in.
In today’s world of bond pricing 1 and 1 doesn’t equal 2 or even 15. It is so far removed from reality that today 1 and 1 equals a chicken.
Below is spot gold in red overlaid by the PIMCO 25-year zero coupon Treasury ETF in blue. They may as well be twins.
I find this correlation fascinating but not unsurprising.
Spot gold (red) and Pimco 25-year zero coupon Treasury ETF (blue)
When bonds are being bought for capital appreciation then of course they’re going to trade like a commodity.
Just as housing in the 2000’s was increasingly bought not of yield but capital appreciation so too today we find ourselves facing the same set of circumstances.
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