Seeking safety in the wake of 2008's market meltdown, investors poured money into U.S. Treasuries driving prices up and yields into the ground. One of the easiest ways to see evidence of the fear that gripped the markets following Lehman's bankruptcy is to take a quick look at a chart showing the price performance of the iShares Barclays 20+ year Treasury Bond ETF (Ticker: TLT) from late October of 2008 to late December--shares of the ETF jumped from around 95 to over 120. Because Treasury prices move inversely to yields, spikes in Treasury prices translate to lower yields on those same Treasuries. This makes sense if you think about it: the more someone wants something (like, say, safety from a stock market that has recently gone crazy) the more they are willing to sacrifice to get it. In the aftermath of the financial crisis investors were willing to give up almost all return-on-investment to have the full faith and credit of the U.S. government behind their money.

While sacrificing yield for safety may make some measure of sense in the wake of a near-financial apocalypse, continuing to be satisfied with yields close to 0 two years after the flood waters have receded makes very little sense. One has to ask how long it will be before the bubble bursts and investors begin moving massive amounts of money out of Treasury bond funds in search of higher yielding investments. The smart money in fact, has already exited U.S. Treasuries. In addition to Buffett's skeptical stance toward owning inflated U.S. paper, Bond king Bill Gross sold all of his U.S. Treasury holdings earlier this year and likens the Federal Reserve's quantitative easing process to a giant pyramid scheme. (R.A.)

Quantitative easing refers to the process by which the Federal Reserve stimulates the economy by purchasing longer-maturing assets with money it creates, thereby driving down interest rates further out on the yield curve (http://en.wikipedia.org/wiki/Quantitative_easing . According to PIMCO (which Gross runs along with Mohamed el-Erian) the Fed, through quantitative easing, has been responsible for 70% of Treasury purchases of late. What this means is that when quantitative easing ends (which, incidentally, it did on June 30), the largest buyer of U.S. paper, has left the market place. An article on PIMCO's website entitled "The End of QEII: Gaining Clarity, Losing the Treasury's Biggest Customer", likens the situation to a supermarket where the biggest buyer of goods quits coming to the store, but the trucks keep delivering goods, and the clerks keep stocking the aisles: with the biggest buyer gone, most of the merchandise simply sits on the shelf (PIMCO). The result is a drastic decrease in Treasury purchases which will drive yields up and prices down. To bring it all home, this means that owners of U.S. Treasuries and U.S. Treasury bond funds and ETFs will see the price of their bonds and shares drop like the stock of an investment bank the Monday after a 'Lehman Weekend'. This will inevitably precipitate a mass exodus of money from U.S. bond funds and ETFs, and then, well...then the panic is on--the bubble bursts.

So what's the trade for the average investor? One option is to buy puts on the iShares Barclays 20+ year Treasury Bond ETF (Ticker: TLT) or the iShares Barclays 1-3 Year Treasury Bond ETF (Ticker: SHY). It may be smarter to buy puts on SHY because a large chunk of the 600 billion the Fed spent in QEII went towards U.S. Treasuries with shorter maturities, and as a result the SHY is a lot closer to its 5-year high than the TLT. The only problem here is that only the TLT has puts listed that expire past December of 2011. I would give myself as much time for prices to drop and rates to rise as possible and buy January 2013 94s at around 12.00. If one goes the SHY route, get the December 2011 85s for 1.50 and hope the bubble bursts sooner rather than later. Even if rates stay low for an extended period keeping these ETFs shares flying high and rendering the options worthless, it is worth the risk to get in the trade before the bubble bursts...afterall, everyone wants to be 'ahead of the curve'--no pun intended

Works Cited

R.A. (18 March, 2011). American Government Debt: Who Will Buy Treasuries? Economist.com. Retrieved July 3, 2011.

Stempel, Johnathan. (28 February, 2009). Buffett Says U.S. Treasury Bubble One for the Ages. Forbes.com. Retrieved July 3, 2011.

The End of QEII: Gaining Clarity, Losing the Treasury's Biggest Customer. PIMCO.com Retrieved July 2, 2011