Last week we talked a lot about the German bund yield, the most important market in the world right now. Today we want to talk about how to trade it.
The best investors in the world love asymmetric bets (limited downside and virtually, if not literally, unlimited upside). That’s the true recipe to building huge wealth. And there is no better asymmetric bet in the world right now than the German 10-year bund.
With that in mind, in recent weeks, we’ve revisited Bill Gross’ statement last year, when the 10-year government bond yields in Germany were flirting with zero the first time. He called it the “short of a lifetime” to be short the price of German bunds – looking for yields to bounce back. It happened. And it happened aggressively. Within two months the German 10 year yield rocketed from 6 basis points to over 100 basis points (over 1%). But even Gross himself wasn’t on board to the extent he wanted to be. The bounce was so fast, it left a lot of the visionaries of this trade behind.
But over the past year, it’s all come back.
Is it a second chance? German yields are hovering just a touch above zero — threatening to break into negative yield territory for one of the world’s most important government bond markets.
As we said on Friday, the zero line on the German 10-year government bond yield is huge psychological marker for perceived value and credibility of the ECB’s QE efforts. And that has huge consequences, not just for Europe, but for the global economy.
Given the importance of this level (regarding ECB credibility), it’s no surprise that the zero line isn’t giving way easily. This is precisely why Bill Gross called it the “short of a lifetime.” With that, let’s take a look at the incredible risk/reward this represents, and a simple way that one might trade it.
There is a euro bund future (symbol GBL) that tracks the price of the German 10-year bund. Right now, you can trade 1 contract of the German bund future at a value of 164,770 euros by putting up margin of 3,800 euros (the overnight margin at a leading retail broker). If you went short the bund future, here are some potential scenarios:
If you break the zero line in yield, the euro bund future would trade up to about 165.50 (it currently trade 164.77). If you stopped out on a break of zero in yield, you lose 730 euros (about $820 per contract). If the zero line doesn’t breach, and yields do indeed bounce from here, you make about 1,500 euros for every 10 basis point move higher in the German 10-year bund yield.
For example, on a bounce back to 32 basis points, where we stood on March 15th, the profit on your short position would be about 4,600 euros (or about $5,200). If German bund yields don’t breach zero and bounce back to 1%, where it traded just a year ago, you would make about 15,000 euros ($16,900) per contract on your initial risk of $820 – a 20 to 1 winner. Of course, there are margin costs to consider, given the holding period of the trade, but in a zero rate world, it’s relatively small.
If you’re wrong, and the German 10-year yield breaches zero, you’ll know it soon.
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On Wednesday we talked about the most important market in the world, right now. It’s German bunds.
The yield on the 10-year German bund had traded to new record lows, getting just basis points away from the zero line, and thus from crossing into negative yield territory for the 10-year German government bond. That has inched even closer over the past two days, touching as low as 1 basis point today.
Not surprisingly, stocks sold off today. Volatility rose. Commodities backed off. And the broader mood about global economic stability heads into the weekend on the back foot. For perspective, though, U.S. stocks ran to new 2016 highs this week, and are sniffing very close to record highs again. Oil and commodities have been strong, and the broad outlook for the economy and markets look good (absent an economic shock).
What’s happening? Of course, the vote that is coming later this month in the UK, on whether or not UK citizens will vote to ‘Stay’ in the European Union or ‘Leave’ continues to bubble up speculation on the outcome. That creates uncertainty. But the real reason rates are sliding is that the European Central Bank is in buying, not just government bonds, but now corporate bonds too. The QE tool box has been expanded. That naturally drives bond prices higher and yields lower. But the question is, will it translate into a bullish economic impact (i.e. the money the ECB is pumping into the economy resulting in investing, spending, hiring, borrowing). As we discussed on Wednesday, it’s the anticipation of that result that sent rates higher in the U.S. when the Fed was in, outright buying assets, in its three rounds of QE.
With that, the most important marker in the world for financial markets (and economies) in the coming days, remains, the zero line on the German 10-year government bond yield. Draghi has already told us, outright, that they will not take benchmark rates negative (as Japan did). That makes this zero line a huge psychological marker for perceived value of the ECB’s QE efforts.
With this in mind, we head into a Fed meeting next week. The Fed has done its job in managing down expectations of a hike next week. With that, they have no risk in holding off until next month so that they can see the outcome of the stay/leave vote in the UK. And, as we’ve discussed, the Bank of Japan follows the Fed on Wednesday night with a decision on monetary policy. They are in the sweet spot to act, not only to reinvigorate the weak yen trend and strong stock trend in Japan, but to add further stimulus and perception of stability to the global economy. We think we will see that happen.
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On Tuesday we talked about the quiet bull market in commodities. Today we want to talk about one specific commodity that has been lagging the sharp rebound in oil, but is starting to make a big-time move. It’s natural gas. And this is an area with some beaten up stocks that have the potential for huge bounce backs.
Natural gas today was up almost 6% to a six month high. The U.S. Energy Information Administration said in its weekly report that natural gas storage rose less than what analysts had forecast. But that was just an extra kick for a market that has been moving aggressively higher in the past NINE days (up 37% in nine days).
Now, we should note, nat gas is a market that has some incredible swings. Over the past three years it has traded as high as $6.50 and as low as $1.64.
For perspective on the wild swings, take a look at this long term chart.
You can see we’re coming off of a very low base. And the moves in this commodity can be dramatic.
Three months ago natural gas was continuing to slide, even as oil was staging a big bounce. But natural gas has now bounced 58% after sniffing around near the all-time lows. Meanwhile, oil has doubled.
Based on the backdrop for oil, broader commodities, the economy we’ve been discussing, and the acknowledging the history of natural gas prices, we could be looking at early stages of a big run in nat gas prices.
Summer is one of the most volatile periods for natural gas with the combination of heat waves, hurricanes and potential weather pattern shifts such as La Nina. During the summer months, a 50% move in the price of natural gas is not uncommon. Another 50% rise by the end of the summer would put it around $4. And four bucks is near the midpoint of the $6.50 – $1.65 range of the past three years.
Billionaires investor David Einhorn has also perked up to the bull scenario in nat gas. In his most recent investor letter his big macro trade this year is long natural gas. Here’s what he had to say: “Natural gas prices are not high enough to justify drilling in all but the very best locations. The industry has responded by dramatically reducing drilling activity. As existing wells deplete, supplies should fall. The high cost of liquefying and transporting natural gas limits competition to North American sources. Current inventories are high following a period of over-drilling and a record warm winter. However, the excess inventory is only a couple percent of annual production, which has already begun to decline. Normal weather combined with lower production could lead to a shortage within a year.”
This all contributes to the bullish action we’re seeing across commodities, led by the bounceback in oil. The surviving companies of the energy price bust have been staging big comebacks, but could have a lot further to go on a run up in nat gas prices.
In our Billionaires Portfolio, we have an ETF that has 100% exposure to oil and natural gas – one we think will double by next year. Join us today and get our full recommendation on this ETF, and get your portfolio in line with our Billionaire’s Portfolio.
We’ve talked about the bullish technical break occurring in stocks. That’s continuing again today.
Remember, a week from this past Friday we talked about the G7 (G8) effect on stocks. We stepped back through every annual meeting of world leaders since 2009. And the results were clear. If the communiqué from the meetings focused on concerns about the global economy, stocks went higher. It’s that simple.
Why? In the post Great Recession world, stocks are the key barometer of global confidence. Higher stocks can help promote economic recovery (better confidence, higher wealth effect). Lower stocks can derail it, and threaten a bigger downturn, if not fatal blow to the global economy.
Policymakers can and do influence stocks. And thus, when we’ve seen clear messaging from these meetings about global economic concerns, stocks have done well (in most cases, very well).
With all of this said, on May 27th, from the meeting in Japan, the G7 issued their communiqué and it started with global growth concerns. They said, “Global growth is our urgent priority.” The S&P 500 closed at 2099. Today it’s trading 2116 and is closing in on the all-time highs set in May of last year (less than 1% away).
Now, we talked in past months about the importance of Europe. The Fed’s best friend (and the global economy’s best friend) is an improving economy in Europe. We’ve seen some positive surprises in the data out of Europe, but the actions taken this morning by the ECB could be the real catalyst to get the ball rolling — to mark the bottom, to get Europe out of the slow-to-no growth, deflation funk.
They ECB started implementing a new piece to its QE program today. Of course, they promised bigger and bolder QE back in March (mostly as a response to the cheap oil threat). Today they started buying corporate bonds as part of that ramped-up QE plan.
With that, this is a very important observation to keep in mind. Over the history of the Fed’s three rounds of QE, when the Fed telegraphed QE, rates went lower. When they began the actual execution of QE (actually buying bonds), rates went HIGHER, not lower (contrary to popular expectations). Why? Because the market began pricing in a better economic outlook, given the Fed’s actions. We think we could see this play out in Europe as well.
Take a look at this chart of German yields. This is probably the most important chart in the world to watch over the next several days.
The German 10-year yield traded as low as 3 basis points (that’s earning 30 euros a year for every 100,000 euros you loan the German government, for 10 years). Of course, the most important visual in this chart is how close the German 10-year yield is to zero (the white line), and then negative rates.
Remember, we’ve said before that Draghi and the ECB have made it clear that they won’t cut their benchmark rate below zero. And “that should keep the 10–year yield ABOVE zero.” Were we right? We’ll find out very soon. If so, and if German yields put in a low today on the “actual execution” of the ECB’s new corporate bond buying program, then U.S. yields would be at bottom a here too.
You can see in the above chart, it’s a make or break level for the U.S. 10 year yield as well (as it is tracking German yields at this stage). While lower yields from here in these two key markets might sound great to some, it comes with a lot of problems, not the least of which is a negative message about the outlook for the global economy and thus damage to global confidence. Keep an eye on German yields, the most important market to watch in the coming days.
This Stock Could Triple This Month
In our Billionaire’s Portfolio we followed the number one performing hedge fund on the planet into a stock that has the potential to triple by the end of the month.
This fund returned an incredible 52% last year, while the S&P 500 was flat. And since 1999, they’ve done 40% a year. And they’ve done it without one losing year. For perspective, that takes every $100,000 to $30 million.
We want you on board. To find out the name of this hedge fund, the stock we followed them into, and the catalyst that could cause the stock to triple by the end of the month, click here and join us in our Billionaire’s Portfolio.
We make investing easy. We follow the guys with the power and the influence to control their own destiny – and a record of unmatchable success. And you come along for the ride.
We charted very closely the risks of the oil price bust. We thought central banks would step in and remove the risk. They did. From there, we thought stocks would track the path of oil. As long as oil continued higher, stocks would follow and slowly global sentiment would mend. It’s happened.
When oil sustained above $40, we turned focus to the extremely negative sentiment that was weighing on markets and economies. But given the extreme views on the world, we thought things were set up for positive surprises. We said this surprise element creates opportunities for asymmetric outcomes (bad is priced-in, good … not at all). That sets up for the potential of “good times” ahead for both markets and broader sentiment.
Fast forward: Earnings expectations were ratcheted down and broadly surprised on the positive side. Global economic data has been ratcheted down and is positively surprising. It’s happening in Germany, which is a very important indicator for a bottoming of the euro zone economy. If the threat of further spiral in Europe has lifted, that’s a huge catalyst for global sentiment. When global sentiment has officially moved out of the doom and gloom camp and back to optimism the horse will have already had plenty of steps out of the barn. And we think we are seeing it reflected in stocks, especially small caps.
With this backdrop, we think everyone could benefit by having a healthy dose of “fear of missing out.” Stock returns tend to be lumpy over the long run. When we you wait to buy strength, you miss out on A LOT of the punch that contributes to the long run return for stocks.
Consider what we said on February 11th (stocks bottomed that day and are up 16% since): “We often hear interviews of money managers during periods like this, and the question is asked “are you getting defensive?”
That’s the exact opposite of what they should be asking. When stocks areup 15–20%, and acknowledging that the long–run average return for stocksis 8%, that’s the time to play Defense. When stocks are down 15–20%, that’s the time to play Offense.
The reality is most investors should see declines in the U.S. stock market as an exciting opportunity. The best investors in the world do. The same can be said for average investors.
Here’s why: Most average investors in stocks are NOT leveraged. And with that, they should have no concern about stock market declines, other than saying to themselves, “what a gift,” and asking themselves these questions: “Do I have cash I can put to work at these cheaper prices?” And, “where should I put that cash to work?”
As Warren Buffett says, bad news is an investor’s best friend. And as his billionaire counterpart says, and head of the biggest hedge fund in the world, ‘stocks go up over time.’ With these two basic, plain-spoken, tenets you should buy dips and look for value.
Broader stocks have just gone positive for the year. Small caps are still down small. Remember, when the macro fog cleared in 2010, small caps went on a tear, from down 6% through the first seven months of the year, to finish UP 27%. Don’t miss out!
Don’t Miss Out On This Stock
In our Billionaire’s Portfolio we followed the number one performing hedge fund on the planet into a stock that has the potential to triple by the end of the month.
This fund returned an incredible 52% last year, while the S&P 500 was flat. And since 1999, they’ve done 40% a year. And they’ve done it without one losing year. For perspective, that takes every $100,000 to $30 million.
We want you on board. To find out the name of this hedge fund, the stock we followed them into, and the catalyst that could cause the stock to triple by the end of the month, click here and join us in our Billionaire’s Portfolio.
We make investing easy. We follow the guys with the power and the influence to control their own destiny – and a record of unmatchable success. And you come along for the ride.
We’ve talked about the bullish technical break occurring in stocks. That’s continuing again today.
