Rotation And Arbitrage

Its all about Rotation and Arbitrage.

If there was a silver lining in the Credit Crisis/Market Meltdown last year it was...US Treasury Securities as well as Dollar based currency's held up and rallied as Bonds and Dollar based assets were considered "Safe Havens". This along with Government Intervention helped stabilize the system and counteract the massive wealth loss that had happened over in equity land. As the US Dollar became stronger, Crude Oil and most commodities (Denominated in $$), became weaker as arbitrage trades had to be unraveled. This helped mitigate wealth loss as people didn't have to pay $4 a gallon for gas.

Also assisting was the US Government making a market for the following:

-US Treasuries.
-Mortgage Backed Securities on the non existent secondary market.
-Purchasing Preferred equity in lousy insolvent banks.

All of this was done via the printing of Trillion upon Trillions of US Dollars.

There was huge rotation globally out of any risky asset class and into secure assets like Treasuries, as investors knew politically (Cave in to PAC Pressure) what the US was going to do.

Crude Oil was a hedge market (Sub Prime/US $$$) for 2007-2008. Sub prime was the catalyst for more gains in crude oil, but what was also lost was that the banks were the ones putting in the hedges. As the financials (GS, MS, LEH, UBS, JP) became weaker and were in survival mode, they had to liquidate/unwind all of their commodities holdings. These trades were put in as arbitrage (Long Commodities/Short US Dollar) trades.
What ensued was the bottom dropping out on Crude, Natural Gas, Corn, Wheat, and a rally in the Dollar. Most arbitrage hedge funds globally were destroyed.

As the equity markets rallied, Treasury rates rose as again, Arb/Safe Haven Trades had to be unwinded. The yield on 10 and 30 year US Treasuries have rallied 130 and 160 basis points respectively this year alone, until recently when the Government was back in trying to push rates down.

Globally the confidence in the US Government/Market was very high, as both Administrations stated they would "Do everything in their power to stabilize the system". Money poured into US Backed/Secured Paper.

This was the situation until recently.

The Treasury has already exhausted almost every possible solution (Except the Obvious), with little or no "real results". They made the US Treasury Market the last resort for investors.

The questions to ask are the following:

1- What happens when foreigners especially China start to sell our US Bonds?
2- What happens when the Treasury can no longer print money to keep rates down?
3- Does the US Government really have an unlimited check book?
4- How large and bloated can the US Balance Sheet become?
5- Why is Goldman Sachs re-leveraging back up to a 20-1 ratio?

I have been predicting lower equity prices for the last month or so based on the fact that the Banks/Financials used one time accounting tricks to over state profits, despite the fact that financial credit spreads barely relaxed during the roughly 80% rally in that sector.

If what I predict comes to fruition, equity prices will again spiral down, but this time there will be no hiding place for investors to park their money, as Treasuries and the US Dollar will plummet as confidence dwindles.