Bear Market in Bonds

I am sure there is but if you have to ask, you are better off staying on the sidelines. But if you must, look at hedge funds. Me, I am savvy enough to know not to get involved in this kind of spec.

Why do you think bonds will fall, because interest rates will rise? If that's so, put your money in certificates of deposit (CDs). I hear they're up to 5% now, and very safe.

gollum wants to short bonds. Doesn't sound like he is savvy enough to attempt that, if you have to ask, stay away. he doesn't even mention what type of bonds he wants to short.

How to Short T Bonds
James Grant, 08.11.03, 12:00 AM ET

When rates finally rise--and they will--you can still make money in the bond market. How? By selling bonds short. A couple of mutual funds are experts at this game.
Read the following press release while sitting down. Grab tight to the arms of your chair: Bethesda, Md., June 26--A survey conducted by Harris Interactive on behalf of ProFund Advisors LLC finds that, although most U.S. investors (57%) believe interest rates will rise in the next two years, nearly two-thirds (65%) are unaware that rising rates generally have a negative impact on the value of bond investments.

So much for the vaunted financial literacy of a new generation of American investors. So much for a decade of nonstop financial news coverage. But wait. Why curse the darkness when we can light a candle?

Make that two candles. The ones I have in mind are a pair of unconventional mutual funds, Rydex Juno fund and ProFunds Rising Rates Opportunity fund. As only an elite minority of investors seems to understand, rising bond yields mean falling bond prices, and vice versa. In these two funds that age-old relationship is reversed. For them, rising yields mean rising prices, and vice versa. Rising Rates and Juno sell the bond market short.

With the understanding that interest rates can't be forecast, I have a forecast: They will go up. I believe that any ten-year Treasury yield beginning with the number "3" (the prevailing rate is just under 4%) is too low. I say this without reference to the business cycle. I believe that the risk of a new inflation is ever present when the Federal Reserve is campaigning against deflation. Possibly, as in Japan, today's very low yields are only a prelude to tomorrow's ultralow yields, and maybe the burden of debt will finally sink the S.S. American Economy. It is more likely, I believe, that the Fed will overprint the dollar, and, in the countdown to the 2004 presidential election, the Administration will overstimulate the economy. Or maybe the cause of rising rates will come out of left field, or from Asia. Conceivably, the sickly Japanese economy will sit up and take nourishment. In the past six weeks Japanese bond yields have more than doubled, to the towering heights of just over 1%.

The Rydex Juno fund is the senior of the two bear bond funds. Established in 1995, its business is to sell short the 30-year Treasury bond, and its goal is to deliver inverse investment performance: For every 1% the bond falls in value, the fund should rise by 1%. Juno's best year was 1999, when it was up 20.4%; this was the year after the collapse of Long-Term Capital Management. Its worst year was 2002, when it was down 16.7% as a weak economy was overlaid on a weaker stock market. Since inception, Juno's not staggeringly wonderful total return has amounted to -4.4% per annum.

The short-seller of an interest-bearing security must reach into his pocket to pay the interest on the security he has sold. Anne Ruff, portfolio manager of Rydex Juno, is currently shorting a 53/8% coupon. Partially offsetting this cost is the interest earned on the cash generated by the short sale and by the money deposited in the fund by the investors: The interest on these balances amounts to 2.4%. Subtracting 2.4% from 53/8%, we get almost 3%, a residual known in the trade as "negative cost of carry." On top of which is a 1.4% management fee. For the privilege of betting against Alan Greenspan, you are therefore paying 4.4%. (Of course, if short rates were higher than long rates, the "cost" of carry would be positive.)

Like Juno, the Rising Rates Opportunity fund is currently paying out more interest than it's taking in. And, of course, like Juno, Rising Rates prospers in a bond bear market. But there are differences between the two. Rising Rates is smaller than Juno ($142 million under management compared with Juno's $542 million) and younger: It came into the world in May 2002. A more important difference can be measured in bang for the buck. Rising Rates strives not for a 100% inverse correlation to the long bond, as does Juno, but for a 125% inverse correlation. This incremental juice it squeezes out with financial leverage, so let the buyer beware. Risk and volatility are commensurately greater than in the unleveraged fund.

It was ProFunds that commissioned the above-quoted survey. Michael L. Sapir, chief executive of ProFunds Advisors, calls the results "scary," as indeed they are. "I think there are going to be a lot of surprised people out there," Sapir concludes. Surprised people don't always make the most well-reasoned investment decisions.

One final cautionary note. According to a new canvass by International Strategy & Investment Group, professional managers are more bearish on bonds than at any time since 1994. We bears may have right on our side, but we can't claim to be betting against the crowd.

deposit certificates with 5% interest? not bad

You can short any commodity (stock, bond, pork belly) that you think will fall in price. Esentially you are borrowing the commodity from someone that owns it with the promise to replace it at a future date.

The difference is when you short something your loss isn't restricted.
If you buy a stock for $100 and it goes to $0 you only lose $100
If you short a stock at $100, there is no limit to how high that stock will go. It could be $1000 in a week and you are looking at a $900 loss. One thing that can happen with stocks that are heavily shorted is if the stock price rises and people that shorted the stock start trying to buy it to stop their losses it can drive the price even higher causing more short sellers to try to cover. Not all short sellers cover because they decided to. Your broker also has Federal limits on how much money you can owe them as % of what you have in your account. When you reach that limit, they will sell without your approval which can force losses or if they sell winners bring about tax consequences you weren't expecting.