Double-Digit Drop Is Likely

The Fed's rate cut sent bond prices soaring... Futures traders now making extreme bullish bets on higher bond prices... Mom and pop piling into the bond market... Double-digit drop is likely...

Red lights are flashing for one of the most-loved trades of 2019...

And investors should be worried.

You see, the Federal Reserve recently took a hard turn in policy. And we've seen major action in the Treasury bond market as a result.

The Fed's decision to lower rates in July created a massive lift in Treasury bond prices. These bonds are now hitting multi-year highs.

Remember, Treasury bonds and interest rates move opposite of each other. That means lower rates point to higher bond prices. That's the consensus today.

And it's one reason why the Fed's recent policy shift has investors excited about Treasury bonds.

For three years, the Fed raised its short-term interest rate...

The economy was in good shape. Unemployment was hitting multi-decade lows. And the Fed raised rates to get ahead of any inflation that could be around the corner.

Things took a turn in late July, though. With the recent trade-war escalations and a couple worse-than-expected economic reports, the Fed reversed course... and cut short-term rates by 25 basis points. This did two things...

1. It signaled that the Fed was concerned about today's current economy.

2. And it created a tailwind for higher bond prices.

Since the Fed rate cut on July 31, long-term Treasury bonds are up 10%. And bonds are now at their highest level since 2015.

This was a massive swing for Treasury securities. But the trade hasn't gone unnoticed. We are seeing several warning signs that could halt today's rally.

In fact, when these indicators are flashing, history says a double-digit fall in Treasury prices is likely.

The futures market is going 'all in' on higher Treasury bonds...

Bets on higher bond prices have reached an extreme in the futures market.

And it's our first clear sign that the recent rally is on its last leg.

When you see this type of setup, it's time to exercise extreme caution. Today, futures traders are making extreme bullish bets on higher bond prices.

The conventional idea is that the Fed's recent lowering of interest rates will continue to send bond prices higher.

But with bets on higher bond prices reaching a multi-year high, the exact opposite will likely occur.

We can see this through the Commitment of Traders weekly report for bond prices. It shows us exactly what futures traders are doing with their money. And it's a great contrarian indicator.

Normally, we simply analyze the total current position of these futures bets compared to the same asset over history. In this case, that's the entire bond market.

But there's a better way to show today's extreme. That's because over time, the number of futures positions that are trading has increased. That means an extreme from five or even 10 years ago might not seem as extreme today.

The best way to account for this is to take current bullish bets from futures traders and divide them by total positions over time. (It's called "open interest.") Doing this gives us a much more useful measure, as you can see on this chart below...

Futures traders recently hit a multiyear bullish level on bonds.

That's the most bullish they've been on higher bond prices in four years...

We saw similar cases in 2013, 2016, and 2017. Each time led to losses in bond prices going forward.

Bond prices fell 16% in the four months following the 2013 extreme. Bond prices dipped double-digits again after another extreme in 2016... ultimately falling 18% by mid-March 2017. And the most recent case in 2017 led to a 9% fall in bond prices.

Today, futures traders are "all in" on higher bond prices. But thanks to these extreme bullish bets, lower bond prices are much more likely.

Worse, futures traders aren't the only ones going in on higher bond prices.

Mom-and-pop investors are pouring into bond funds...

One of the simplest ways to bet on higher bond funds is through an exchange-traded fund (ETF). These funds hold a basket of bonds and allow mom-and-pop investors to easily take part.

Today, bond funds are seeing massive inflows of investors buying up shares.

Take the iShares Barclays 20+ Year Treasury Bond Fund (TLT)... TLT holds a basket of long-term Treasury bonds and can create or liquidate shares based on demand. So a falling share count means investors aren't interested... And a rising share count tells us investors are piling into a trade.

Today, shares outstanding for TLT are near all-time highs. Mom-and-pop investors are buying into this strong rally. And shares outstanding have risen roughly 75% since last August.

It's an understatement to say the recent rally in bonds hasn't gone unnoticed. We are seeing extreme bullish bets on higher bond prices in the futures market. And we are seeing mom-and-pop investors pile into bond funds like TLT.

That's not all though... We are seeing one more signal flashing a major red light for bonds...

TLT just hit the highest 'overbought' level since December 2008...

You know the theme by now... When investors go all-in on an asset like bonds, it's a great time to bet against them.

Another way to see this bullishness is through TLT's extreme overbought levels...

When I say overbought, I'm talking about the Relative Strength Index ("RSI"). It's a contrarian indicator that tells us when investors have gotten ahead of themselves. And it's a great way to see when a trade has moved too far too fast in either direction.

An RSI level above 70 signals an overreaction to the upside... breaching into overbought territory, while an RSI level below 30 triggers an oversold extreme.

As I write, TLT is in extreme overbought territory. Take a look...

TLT's RSI level broke above 83 on Monday. There have only been two other cases when TLT was this overbought – both in 2003 and late 2008. Look at what happened after those extreme overbought levels...

Each instance led to double-digit losses over the next year. And it's another flashing red light in the bond market.

We're not recommending fighting the uptrend that's in place today...

Bond prices have taken off in the past few weeks. TLT is up 20% so far in 2019.

But the fact remains, we are seeing several warning signs in the bond market. The upside in bond prices is likely limited in the short-term.

We are seeing extreme optimism in both the futures market and in ETFs like TLT.

When the uptrend starts to break down, we could see a sharp drop in bonds over the next few months. And a double-digit fall isn't just possible... It's likely.

New 52-week highs (as of 8/14/19): Alexco Resource (AXU), DB Gold Double Long ETN (DGP), SPDR Gold Shares (GLD), Polymetal (LSE: POLY), Vanguard Inflation-Protected Securities Fund (VIPSX), and short positions in Advance Auto Parts (AAP) and iShares China Large-Cap Fund (FXI).

Several folks have already chimed in on the new and improved Stansberry Research mobile app. We also received an interesting response to paid-up subscriber B.C.'s gold coin question. As always, send your notes to feedback@stansberryresearch.com.

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"Guys, I am thrilled you finally released the app. At a glance, it looks a lot better than the previous one. I used to access the updates in the mobile app a lot! Then there was scroll/page rendering issue that prevented me from using it. I was disappointed. Glad you guys worked on improving the app!" – Paid-up subscriber Steve S.

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"Hi, the app works great, and is much easier than logging in to the mobile browser... " – Paid-up subscriber Matthew K.

Brill comment: We're glad to hear folks are enjoying the new app so far. We've already received some great suggestions for further improvements, and we'd love to hear what you think as well. Again, our new app is available to download for free in both the Apple App Store (right here) and the Google Play store (right here).

"[In yesterday's Digest, a reader mentioned a magazine ad offering] American Eagles for $135... I [also] had serious doubts about the validity of this mail piece when I received it. I called the number and was connected to a sales rep who answered all my questions and then proceeded to show me the wonderful deals available to me with high MS value bullion coins.

"I refuted his claims as I told him that 'bullion is bullion,' and when the SHTF, an ounce of gold was worth an ounce of gold... He thanked me for my opinion and was gracious upon parting. Three days later, I received my 10 1/10 ounce coins.

"This is a 'loss leader' advertisement... I had to use my kids address to qualify for the promo as this it is a one-time deal." – Paid-up subscriber Frederick S.

Brill comment: Thanks for the note, Frederick. As we suggested yesterday, if a company is offering to sell you gold for well below market price, there's probably a catch. In this case, it appears the company in question is using this low-priced offer to entice customers to buy additional coins at inflated premiums.

For those readers who aren't familiar, "MS" stands for "mint state." This is one of the terms used to describe the condition of rare, collectible coins. All things being equal, coins with a higher grade fetch a higher price.

But grading shouldn't be a concern when you're buying common bullion coins like the American Eagle.

Remember, bullion is bullion... Its value is primarily based on the value of the gold or silver it contains. So it makes no sense to pay extra for a brand-new American Eagle in pristine condition. If or when you go to sell it, a dealer will generally offer you no more than they would for any other bullion coin.

Unfortunately, many folks don't understand this... and some firms can take advantage.

Regards,

Chris Igou
Jacksonville, Florida
August 15, 2019