The biggest risk...

This week, in a little-noticed announcement, Fidelity Investments disclosed that the size of its bond and money-market assets under management currently total almost $850 billion. That's more money than the company manages in stocks. Thus, Fidelity – which has long been middle America's leading stock-fund manager – is now its leading bond-fund manager.

As you know, in the Friday Digest –which I write personally – I strive to tell you something I believe is very important. Something I'd want you to tell us, if our roles were reversed. Today, I'm going to update you on what I've long considered the single most important trend in all of finance – the growing likelihood of a catastrophe in the world's bond markets.

Just as investors have finally lost their love of stocks and begun to shift their assets (by billions every month) into bonds… I believe we are on the brink of a decade-long bear market in bonds. These forces (which I'll explain below) will destroy the savings of millions of Americans, who don't understand the enormous risks right now in the bond markets.

The current bull market in bonds began on October 6, 1979. On that day, the chairman of the Federal Reserve began taking actions to remedy the monetary chaos of the 1970s. He announced that the Fed would begin to "target reserves." That is, the central bank would deliberately restrain growth in the money supply.

While fears of further inflation didn't die overnight and bond prices continued to fall into the early 1980s (with the prime rate topping out at around 20%), the Fed's then-Chairman Paul Volcker was as good as his word. Bond yields began to fall. On long-term (30-year) government bonds, yields topped out at around 15%. By the time these bonds reached maturity (in 2010), the yields had fallen to 3.5%. Today, incredibly, the yield on newly issued 30-year Treasurys is lower still – below 3%.

Most people believe the bull market in stocks that ran from 1981 to 2007 was the greatest bull market of their lifetimes. It wasn't. An investor buying 30-year government debt on January 2, 1980 would have made more money than an investor who bought the 30 stocks in the Dow Jones Industrial Average over the following 30 years.

What I want you to understand is this: The bull market in bonds has been the greatest bull market of the last 100 years. But the forces that created it have now been reversed.

What created the incredible bull market in bonds? Volcker's decision to target reserves reduced the U.S. monetary base. Over time, that restricted credit. The Federal Reserve largely maintained this policy under Volcker's successor, Alan Greenspan.

However, the current chairman, Ben Bernanke, has deliberately reversed this policy. He did so at first through the Fed's massive buying of mortgage assets via the Troubled Asset Relief Program (TARP), in the government's attempt to bail out banks threatened by the 2008 credit crisis. It continued on an even bigger scale through two rounds of "quantitative easing." First in March 2009 and then in the fall of 2010, the Fed created additional trillions in reserves through massive asset purchases.

In total, the Fed has now tripled the size of the U.S. banking system's monetary base. Worse, for bondholders, Bernanke recently pledged to expand his policy through continuous reserve purchases on a scale that effectively provides cover for the entire annual federal deficit. This sets the stage for massive future increases to price inflation in our economy... and will eventually cause a massive bear market in bonds.

You can track these inflationary pressures by simply watching the price of gold as compared with the price of the U.S. long bond. I use Yahoo Finance to keep an eye on the spread between the gold bullion fund, SPDR Gold Trust (GLD), and the iShares Barclays 20+ Year Treasury Bond Fund (TLT).

As you can see on the chart below… since the beginning of the financial crisis, gold has far outpaced the value of the U.S. sovereign bond. The reason should be obvious to all: You cannot print your way to prosperity. The more America must finance its excessive government spending with paper money, the less paper money will buy in terms of real goods, like gold. You can see the comparison between gold and bonds in this two-year chart:

Over the last five years, the price of gold has gone up almost 150% – thanks almost entirely to the efforts of the Fed and the European Central Bank to inflate away their debts and finance their deficit spending with paper money. Incredibly, the U.S. long bond has gone up, too – by about 50%.

Why have bonds continued to go up, too? Two reasons. First, when the Fed increases the money supply by purchasing new reserve assets, it typically buys government bonds. In the short term, this forces down bond yields (and pushes bond prices higher). Speculators, anticipating the Fed's actions, amplify this effect.

Second, most investors don't understand the monetary risks of the bond market and view bonds simply as a safe haven. As investors have sold stocks in fear, they've bought bonds in a misguided attempt to reduce the risks in their portfolios.

I cannot predict when the collapse in the bond market will begin. But I know it must collapse. Ben Bernanke has deliberately destroyed the underlying monetary conditions that created the huge bull market in bonds. By watching the price of gold as compared with bonds, you can see the pressure building on the bond market. The higher gold goes... the more pressure mounts. Sooner or later, these inflationary pressures will spook the holders of U.S. sovereign bonds. And… when they decide to sell, it will cause a catastrophe.

All the bond markets in the world – all other sovereign bonds, all mortgage bonds, and all types of corporate bonds – derive their prices through comparison with the U.S. Treasury 10-year "benchmark" bond. As U.S. credit goes, so goes the value of paper money all around the world.

These risks are something few people appreciate today – as is evidenced by the huge inflows into the bond market and the soaring assets under management in Fidelity's fixed-income products. No, I do not expect an imminent collapse in the world's bond markets. But I do believe such a moment approaches.

I believe so because of the underlying monetary conditions I explained above.

I believe so because every bull market eventually comes to an end... and the bond bull market has been the biggest and longest bull market of my lifetime.

I believe so because real measures of price inflation have already driven the yield on the U.S. 10-year Treasury bond negative.

And I believe so because many other key central banks in the world's paper currency banking system have already begun to stockpile gold, notably Russia and China. These kinds of changes... and the excesses I see in the bond markets... will not last long.

I recommend hedging your exposure to fixed-income assets with gold and silver. Likewise, in this market, I would prefer to own high-quality, dividend-paying (and dividend-growing) stocks as opposed to low-yielding corporate debt. Finally, and most important, I would avoid all long-dated government bonds.

This advice might sound too simple for many of you... who'd prefer a stock or option-trading tip. But... I believe this warning is, by far, the most valuable piece of advice we have to offer today. I hope you'll take it seriously.

New 52-week highs (as of 9/27/12): SPDR IND INTL Health Fund (IRY), Sandstorm Gold (SSL.V), Virginia Gold Mines (VGQ.TO), Eli Lilly (LLY), Monsanto (MON), Royal Gold (RGLD), 1st United Bancorp (FUBC), Walgreen (WAG), Sysco (SYY), Home Federal Bancorp (HOME), and Fluidigm (FLDM).

In the mailbag... a reader who's had tremendous success with our safe options strategies. Her subject line read: "I GET IT!" Congratulations.

In this volatile world, our safe options strategies are among the best ways to generate income. I applaud your success. Let us know if you agree/disagree with our bond market analysis here: feedback@stansberryresearch.com.

"I was sorry to hear people are doubting Doc Eifrig and Stansberry Research in general... So I wanted to write in. I just started selling options last January on my own, but I caught on quickly and by May I was selling naked puts mostly on my own... But with the encouragement from Stansberry, I had the confidence to forge ahead...

"My first 3 puts got assigned to me... mainly because the market in general took a dip. I was NOT upset by this... I have sold covered calls on all 3 of these [stocks] and made even MORE money... [One stock] got called and I made $6,000 in capital gains!

"I have gotten many great ideas from all the great guys at Stansberry... I am so happy that I just bought a Flex Alliance program. I totally understand how Doc Eifrig's track record works... I learned from your training videos (and my own common sense) that you can buy to close and (re)open to sell for more money or to at least delay and 'buy' time.

"I find your newsletters very informative and often the feedback section has me laughing out loud... I love getting up each morning and can't wait to start looking at the market and what might be a good option to consider. I am an RN (retired) and was a pharmaceutical sales rep for many years, but I have never had so much fun making good money being an options trader. I hope to be doing this for a long time and really learning a lot along the way... My son is a junior at Stanford and is very interested and impressed with my success... I hope to be able to leave him a very nice portfolio. So far this year I have earned over $56,000 on options ALONE, this doesn't even count the capital gains $$$ I've earned on selling covered calls that did get called! Thanks and keep the great ideas coming!" – Paid up subscriber Kim Crain

Porter comment: Thank you for the note, Kim. Helping readers understand how to safely sell options in order to generate income is something we are proud of at Stansberry & Associates.

"Hey, since you guys are the BEST-- AND I'M SERIOUS, HAVING SUBSCRIBED TO OVER 70 NEWSLETTERS OVER THE LAST 30 YEARS, why don't you 'break the mold' on videos. Tell us up front if a video will follow and tell us how long it will be and – important, give us the option to scroll forward and back. For us guys over 50 we sometimes don't get it at the fast pace of some of the videos. The option of scrolling back to hear the info again would be most welcome. You would knock your competition out of the box!

"When I go to a 'teased' ad, and I see it's going to be a video, I just close it out and move on. This has saved me countless hours of watching something I later don't want to follow. Thanks for your great work and info." – Paid up subscriber J.G. Frank

Porter comment: We admit to being aggressive marketers. That is, we spend heavily to sell our products. We also rigorously test (and re-test) the techniques we employ to get the highest return on our marketing. You should expect that from a company owned and led by a financial analyst.

You might be surprised to know… like you… I personally don't like our video sales letters. But they always win in our marketing tests. Likewise, giving people stop, start, and rewind buttons reduces response rates. I don't know why that's so… but I know we've tested it thoroughly.

However, if you don't want to watch our videos, all you have to do is click the "back" button on your Internet browser. Doing so will bring up a plain text letter copy. You can simply read it at your leisure. (And I hope you will.) And I hope you have noticed, in the Digest, we have begun noting when a link leads to a video.

One last point... lots of new subscribers wonder why we use 'hype-y' sales letters. We use them because they work. If they didn't work, we wouldn't use them. The upside for you is our advertising allows us to remain totally independent. We don't do any banking. We don't offer any brokerage service. We don't manage any money. Our business model is based on advertising and subscriptions. That's what allows us to produce such high-quality financial research and to sell it – without any conflicts of interest – at a very low price.

And if you want to avoid all of our advertising, just sign up to join our S&A Alliance partnership. The Alliance gives you access to everything we publish (except for Phase 1 Investor) on a lifetime basis for one fixed price. To find out more, call our membership director, Mike Cottet, at 888-863-9356.)

Regards,

Porter Stansberry

Baltimore, Maryland

September 28, 2012

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