Almost exactly a year ago, I mentioned a paired-trade between the long-term Bond ETF (TLT) and short-term corporate/sovereign bond ETF (AWF).  I went long AWF and shorted an equal dollar amount of TLT. Last week, I closed the position after holding it for just over a year.

When I entered the trade, AWF was trading for $8.29 and had a yield of 13.4%, while my short position in TLT was trading at $112.10 and had a yield of 3.5%.  When I close out my position a year later, AWF had a price of $13.10 and a yield of 8.6%, while TLT was going for $91.65 and yielding 3.9%.

I made about 63% on the long AWF position and 18% on the short TLT position. Coupled with the 9.9% net dividend yield, that trade made me ~91%. Not a bad return for a year and 4 days.  Bond yields don’t usually move 500 basis points in a year. No point being greedy. Time to bank some profit!

A drop in the stock market will cause the price of bonds to move up, since they typically are inversely correlated. Similarly a sharp rise in in yields would cause bonds price to drop. I expect a move in TLT to about roughly $96 at which point I might renter the position depending on the larger macro-economic picture.

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Here’s an interesting article by Dominic Frisby about Venezuela’s devaluation, the effect on a country’s currency and the relation with gold prices.

Gold bugs are forever telling you to buy gold because it is ‘nobody else’s liability’. It’s become one of those hackneyed phrases that has almost lost its meaning.

But recent events in Venezuela give us a nice illustration of what that phrase really means. And there’s a stark, but important message for savers everywhere.

Inflation is currently running at 27% in Venezuela. That’s just the official figure. You can expect the real number to be considerably higher.

Earlier this month, the Venezuelan president Hugo Chavez, devalued the bolivar by half, from 2.15 per US dollar to 4.30 per dollar. There will be a second peg, subsidised by the government, of 2.60 bolivars per dollar for essential imports such as food, medicine and machinery.

This devaluation has effectively doubled the cost of imported goods and halved the Venezuelan people’s purchasing power in a single stroke. Savers – though I doubt there are that many given the country’s precarious situation – will have had half of their wealth effectively wiped out overnight.

Chavez is doing it, he said on state TV, ‘to boost the productive economy, to reduce imports that aren’t strictly necessary and to stimulate exports.’ But that won’t be the effect. All his actions will do is discourage people from working at all. Leaving aside the moral issue of whether government should have the power to do that (and, largely speaking, with our modern system of money and credit, they do), many Venezuelans will now ask themselves: ‘What is the point of my working at all, if the proceeds are going to be devalued so suddenly?’

But any Venezuelan who happened to have converted some of their wealth into gold would be protected from these government foibles – at least, as much as is possible under the circumstances. [LOD"s note: Not only gold and silver, but even real estate would hold its price in an event like this. Over the long term, real estate matches inflation, and to some degree population growth]. Chavez cannot suddenly devalue gold by half to ‘boost the productive economy’. So the proceeds of that individual’s labour would have been preserved. The purchasing power of gold against essential goods such as food, energy and shelter remains unchanged – in fact it’s probably risen.

I remember backpacking across South America in the early ’90s. Venezuela was one of the wealthiest, most advanced nations on the continent. It’s such a shame to now see the country on Hayek’s The Road to Serfdom, or, worse still, to Zimbabwe.

“Chavez”, writes Daniel Cancel on Bloomberg, “is trying to maintain spending for his 21st century socialist revolution as South America’s largest oil exporter fails to emerge from its first recession in six years. The government is seeking to stem its falling popularity and the highest inflation rate among 78 economies tracked by Bloomberg, ahead of parliamentary elections scheduled for September.”

Well, isn’t our own government doing the same thing? Haven’t they boosted spending over the last three years in an attempt to stem falling popularity ahead of an election? Isn’t quantitative easing an elaborate form of currency devaluation? The effect of their actions has been that sterling has been losing its purchasing power. It buys us considerably less food, energy, medicine, industrial goods and anything else you care to mention (except mass manufactured goods from Asia) than it did five years ago.

It even buys us less foreign currency, as the chart below – which shows sterling against a basket of foreign currencies – shows. (I’ve drawn on that white line highlight the market direction) The only reason sterling has not fallen further is that other foreign central banks have been doing the same things to their own money. It is a race to the bottom.

Our currency has devalued many times before. Anyone who remembers 1976 can tell you about the sterling crisis then. Financial markets were losing confidence in the pound. (I believe that loss of confidence is coming again. If sterling drops below $1.57 against the dollar, look out below).

The UK Treasury could not balance its books, while Labour’s strategy emphasized high public spending. The newly-elected prime minister, Jim Callaghan, was told there were three possible outcomes: a disastrous free fall in sterling, an internationally unacceptable siege economy, or a deal with key allies to prop up the pound while painful economic reforms were put in place. What will David Cameron be told should he win in the summer? The parallels to today are uncanny.

In more recent memory, we have had the sterling lows of March 1985 (when we almost hit parity with the dollar), then another crisis with ‘Black Wednesday’ in October 1990, when we were forced to drop out of the European Exchange Rate Mechanism.

What is worrying is that our current deficits, debts and spending are all at far greater levels than during any of the previous crises. So many toxic assets have been transferred from the balance sheets of banks to governments, that sovereign debt default – not just here, but throughout the Anglo-Saxon economies – is now a major risk.

You can read the entire article on moneyweek.

So Why should you care?
If you invest in US companies that do business with Venezuela, then your portfolio returns will definitely be adversely impacted. US companies that do business with Venezuela like Haliburton are likely to feel the impact of this currency devaluation. Haliburton CEO just announced that they may face a $30 million loss in the 1st quarter because of this.

While I liquidated almost my entire stock portfolio at the market open this morning (including Harvest Natural Resources which does business in Venezuela), I’m still keeping my gold and silver coins!  Talking the about market, its risen 50% since the March lows of last year. I might even go short some weaker stocks on any market bounces too.

Related Posts

• October 6, 2009 -- Gold Hits Record High!
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• March 6, 2009 -- Global Economic Recession: Coming To A Town Near You!
• January 31, 2009 -- Another Case For Gold
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Today the baby Berkshires (BRK.B) split 50 to 1. And it’s up 4%! This was to be expected. The stock is now affordable to many small investors and there is talk about it being added to the S&P500 index.

When the stock split was first announced, I had a brilliant idea to sell my baby Berks on the news and then re-buy them just before the split. I figured that the euphoria of the split news would push the stock higher and then the enthusiasm would die down and I could buy them back lower.  So the stocks that I bought at $2,550 (split adjusted price of $51) were sold at $3,500 (split adjusted stock price of $70).

My plan worked. The stock drifted down to $3,250. I would’ve been happy to buy them at $3,300. Especially since the current price is $72.25 or just over $3,600 pre-split price. Unfortunately, with my busy school schedule, I totally forgot to put in a buy order and ended up buying the stock back at $71.

Sometimes it better to not try and optimize everything! How many of you are buying BRK-B now that it’s more affordable?

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Here’s an excellent video about an empty city in China that has been built using government funds. Ploughing billions of dollars in infrastructure and construction works theorectically improves the GDP but benefits no one (unless you count the companies that were awarded the contracts), and actually punishes tax-payers. But of course, the people reaping the rewards are not those being punished so there is no incentive to change the way things are.

The government bailout of poorly run companies (via direct investment and subsidizing of their products) also distorts the GDP. GDP numbers in the US without the Trillion dollar bailout would not look so rosy.

Despite all the talk of the economy being out of recession, 39 million people in are on food stamps. [source: USA Today] Thats 12.65% of the US population! And 6 million of that number have no other source of income. In what was once the world’s most prosperous nation, 2% of people would starve if the government didn’t send them food stamps.

Maybe they should start blogging to earn some online income. I see that LivingOffFoodStamps.com is still available!

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Suzie Orman is a famous financial planner who appears regularly on TV and is a prolific writer. I’m not a big fan, mostly because her ideas are too simplistic for me although they must appeal to a lot of people who have no knowledge of financial information.

But now and then she has a good nugget of information. Check out this short clip about paying off your home mortgage as soon as possible.

The only counter argument I can think of is inflation.

If you bought your house in 1980 for $50,000 and never paid off the mortgage (that wouldn’t be possible unless you refinanced the home loan along the way), the value of $50,000 today is a lot lower than it used to be 30 years ago.

But on the flip side, the mortgage interest tax deduction on $50,000 is rather small too. So maybe you should send in that extra $100 every month!

One resource I strongly recommend is How to Save Thousands of Dollars on Your Home Mortgage. You can buy the book used on Amazon for under $2.00 – possibly the best 2 bucks you’ll ever spend!

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