Bonding With High Risk Junk

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Published : December 12th, 2012
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It is very difficult to make money in choppy non-trending markets. When politics is unstable, this makes it even worse. With high-grade bonds returning less-than-true inflation, investors and bond traders get busy with Junk Bonds as a last resort.

“In finance, a high-yield bond (non-investment-grade bond, speculative-grade bond, or junk bond) is a bond that is rated below investment grade. These bonds have a higher risk of default or other adverse credit events, but typically pay higher yields than better quality bonds in order to make them attractive to investors.” -Wikipedia

It is our contention that the global bond markets are overloaded with all kinds of bonds, whether they are of investment-grade, corporates, central bank bonds, infrastructure and municipal bonds or whatever.

We think it is very clear the Federal Reserve is on overload in the amount of paper they have offered, they are currently offering at auction, or plan to offer in the future. In a recent report we said the Federal Reserve is now at a point where they are having difficulty selling nearly 60% of the regularly offered auction paper.

The net result is a turning point in yield rates. Investors will demand higher interest rates for additional risk.

Europe is in a credit mess. Investors from Europe are buying Bernanke’s paper as a safe haven out of fear, and demand for security. This has calmed down and mitigated some risk for US paper for the intermediate term of a few months. However, the risks are rising again as the international credit markets are all intertwined. The forecast for bonds is: run away!

Should we get a nasty credit event in a major market, which is surely coming, it is not beyond our imagination to see a rolling crash in the primary bond markets with too many investors running for the exits all at once. If so, this becomes that grand moment in time when we could see a cascade of bond defaults, crashing in an unstoppable waterfall of valueless debts.

Risk is beyond comprehension of most investors and traders.

“The holder of any debt is subject to interest rate risk and credit risk, inflationary risk, currency risk, duration risk, convexity risk, repayment of principal risk, streaming income risk, liquidity risk, default risk, maturity risk, reinvestment risk, market risk, political risk, and taxation adjustment risk. Interest rate risk refers to the risk of the market value of a bond changing in value due to changes in the structure or level of interest rates or credit spreads or risk premiums.

The credit risk of a high-yield bond refers to the probability and probable loss upon a credit event (i.e., the obligor defaults on scheduled payments or files for bankruptcy, or the bond is restructured), or a credit quality change is issued by a rating agency including Fitch, Moody's, or Standard & Poors.” –Wikipedia

Have you noticed all the credit rating agencies downgrades for central bank paper like Greece, Spain and France? Even the USA got a credit-debt downgrade!

Some of our top analyst friends are saying this is inevitable and that it’s not a question of if it happens, but when it happens. If you are trying to exit risky paper or maybe even high grade paper, and these markets hit the dumpster, it’s too late and you won’t get out without major losses, in our opinion. The simple reason is: there will be not be enough buyers taking the other side of this trade.

Bubble Magnitude of Junk Bonds Issued is Legendary

Wikipedia went on to report…“Global issue of high-yield bonds more than doubled in 2003 to nearly $146 billion in securities issued from less than $63 billion in 2002, although this is still less than the record of $150 billion in 1998. (The) issue is disproportionately centered in the United States, although issuers in Europe, Asia and South Africa have recently turned to high-yield debt in connection with refinancings and acquisitions. In 2006, European companies issued over €31 billion of high-yield bonds. 2010 was a record year for European Junk Bond issuance, with as much as €50bn expected.

“In the US, high yield bond issuance after the financial market meltdown of 2008-09, produced $317 billion in offerings through the first 11 months of 2012, besting the then-record $287 billion seen in 2010.”

Housing Related Bonds and Credit Ready to Smash

In June of 2005 we reported in Trader Tracks Newsletter that the housing markets would crash based upon two key events: (1) As commodity futures traders, we watched as the lumber futures took a dive on that date. (2) Next, we observed new housing prices in hot markets rise over 100% from 2003 to 2006. This was encouraged by Mr. Greespan’s easy, low interest rates permitting too many unqualified buyers to purchase homes way beyond their ability to pay.

That was seven years ago and housing remains a severely damaged market sector. At its very foundation, the credit and bond markets are wrecked. Worse yet, the housing related bonds are soon to be joined by commercial real estate paper in the trash, as the leases in office buildings and the retail sector continue to fail and unwind.

Recent action in residential and commercial real estate gave some green shoots encouragement. However, if you look closely, you can see two major USA department store chains failing badly. We have reported on this for over 3-4 years and now it is getting worse.

The hottest, biggest, extensive retail market in the world, Hong Kong, China has reported luxury rents at $15,000 a square foot. We find this preposterous and so do the tenants as they are leaving as fast as leases expire with no renewals. The retail chickens are coming home to roost. You cannot push on a “charge more” string forever.

Municipal Bonds for Community Finance are Breaking Down

In 2010, Meredith Whitney (a top credit analyst) reported that 100 USA communities would soon default on their bonds. She was unfairly and harshly criticized. We view her work as among the best in this field. Mrs. Whitney was just a little early. In the investment business it is much better to be early than late. If you are a tiny bit too late you can lose a bundle in a flash. Please note the counties, cities and towns in California, the Midwest and Alabama for failure examples.

This is just the tip of the iceberg as a torrent of failures is coming. The interest on these municipal bonds comes from real estate and business taxes. With so many failures in this sector the bond interest due from taxes is simply not available to pay the bills.

“In the first 11 months of 2012 companies sold a whooping $324 billion in junk bonds, according to Dealogic. That means with one month to go in 2012 the speculative junk bond bubble is more than DOUBLE the size of anything we saw right before the 2007-2008 crash!” –Mike Larson, Money & Markets 12-7-12

There are several ETFs and related indexes for investing in bonds of all kinds. There are also two signal-indicator indexes measuring volatility and market attitudes towards investing in bonds. At this point from a technical analysis standpoint, the red warning lights are flashing on all of them. We are planning an essay in Trader Tracks Newsletter to elaborate on this problem/opportunity. The story will offer trading ideas and suggestions to protect investors and enhance trades for gains.

Even if you were holding a large package of junk bond investments and had offsetting trades with put option spreads or positions, we have to wonder who can cover in the event of a major market meltdown? In our view, the damages would be overwhelming and the insurance credits (puts) could not be paid nor covered. The cash demands could simply overpower the ability to pay.

We already learned from the explosion of derivatives used for real estate and other credit markets what happens on those so-called insurance policy trades! Big banks were hit so hard they became insolvent and were propped up using TARP funds, which were paid by US taxpayers.

Big banks or writers of these derivatives simply cannot cover going into default. The banks have buried them in back rooms off-balance sheets to get them out of the way of more similar trading. This is like keeping two sets of books and we say it’s fraudulent. This is not news and has been written about extensively by top analysts who report on our industries, the economy and markets.

Hard Assets are Best Investment - Not Fiat Paper

It is obvious to us that hard assets are the answer. It all starts with physical gold and silver.

Somebody please tell us when the global bond markets crash for good and we’ll tell you when this can all get better and we can start over again, maybe with a partially backed fiat gold currency.

Roger Wiegand

Contact Claudio Bassi, at Trader Track’s New York City publishing offices for a trial subscription.  Call 718-457-1426  Monday through Friday, 9:30am to 5pm or, e-mail

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Roger Wiegand is the Editor and co-partner of Trader Tracks. He alone is responsible for all writing, editing and content. Roger's publisher is Taylor Hard Money Advisors, Inc (THMA) in New York City. Roger Wiegand found and put together his first real estate-mining joint venture with his real estate developer employer in the early 1970's with a USA national, public gravel miner.
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