Yesterday, I talked about why inflation and rising interest rates are pretty much a “sure thing” because of all the “new money” the Fed created through its quantitative easing programs. And I suggested that once they really kick in, the correct investment could generate at least 50% gains.
But there is no way to tell exactly when that will happen. It could be in six months, it could be in 18 months. Nobody knows for sure.
In the meantime, there is something else to consider: the rates on US Treasuries. This is Part A of the equation that I mentioned yesterday – and this is where the short-term money is made. It has handed followers of my Trend Trader portfolio a 12% gain already. And it should continue to make them money until the inevitable inflation and rising interest rates begin.
See, the US sells Treasuries to fund the government. And it has been selling massive amounts of Treasuries for quite a while now. China, for example, currently holds over $1.6 trillion in US Treasuries.
But buyers know the US is looking at many years of higher inflation. So to keep them interested in buying our debt, the Fed has to offer increasingly higher rates. To find buyers for its 30-year bonds during the December auction, the Fed had to offer 4.41%. In January, it was 4.515%. In February, it was 4.75%.
And here’s why that is making my Trend Trader followers money until Part B (higher interest rates) and Part C of the equation come into play:
All of these 30-year Treasury bonds are put into long-maturity bond funds. One example is the Barclays Capital U.S. 20+ Year Treasury Bond Fund.
Now… a basic investing principle is that when interest rates go up, the value of bonds drops. The longer the maturity of the bond, the more it gets clobbered. (On the flip side, when interest rates are falling, the value of bonds goes up.)
So when the Treasury has to offer higher interest rates when it sells long-maturity bonds (like it’s done from December through February), it drops the value of the bonds it just sold a month or two earlier.
That means the value of the funds holding those bonds drops too.
And because my Trend Trader followers own an investment that actually rises in value as these bond values fall, they have made money over the last six months every time the Treasury has had to raise rates to attract buyers.
The chart above seems to indicate that the Treasury will have to keep raising rates. This means Part A will continue to deliver profits until Part C (inflation) kicks in.
I should rephrase that.
Until inflation gets to the point where the government can no longer ignore it.
The Fed will then have no choice but to start raising interest rates to try and bring inflation under control. When that happens, it will affect the value of all bonds here in the US, including Treasuries.
Here’s How the Soup Is Made
Remember when I said that the longer the maturity of the bond, the more it gets clobbered when interest rates rise?
Well, there is a bond fund that holds Treasuries with 20+ year maturities. And it has already been losing value. But when the Federal Reserve has to raise interest rates to battle inflation, it is going to get absolutely crushed.
We don’t want to invest in that fund.
Instead, you should own an investment that goes up in value as that fund goes down in value.
I have identified the one that I think stands to gain the most as inflation takes root and the Fed has to raise interest rates. As I said, it has already gone up 12% in the six months since I told followers of my Trend Trader portfolio about it. To sign up for the Trend Trader and learn the name of this investment, click here.[Ed. Note: Christian Hill manages the Trend Trader portfolio for the Liberty Street Investor. To gain full access to his portfolio, sign up for the Liberty Street Investor here.]