ETF Talk: Is the Boom in Treasuries About to Bust?

The U.S. national debt is more than $5 trillion and those of us who pay taxes are on the hook for it. To give you an idea about the gargantuan U.S. debt load, the government owes its creditors more money than the annual gross domestic product of any other country in the world. To finance the debt, the U.S government borrowed nearly $550 billion last quarter and $530 billion in the previous quarter — funded by U.S. Treasury bonds. Although the Treasury market boomed in 2008, it soon could bust. Investors need to decide which side of the Treasury market to take and when.

Here’s my view. The growing Treasury debt could fuel inflation as the U.S. government boosts the money supply by printing additional dollars. The current low bond yields do not offer investors any protection from inflation. My recommendation is for you to maintain a high cash position in the short-term.

I also would avoid making any new investments in Treasury bonds. The need of the U.S. government to issue Treasury bonds looms large during the next couple of years. The federal government’s expansive borrowing is destined to grow further as President Obama’s economic stimulus package is estimated to cost more than $2 trillion in 2009 alone.

If the economy begins to recover by late 2009 or 2010, watch for interest rates to climb and the price of Treasury bonds to drop. Since I expect the economy to recover sooner or later, a decline in the Treasury market seems inevitable and already may be starting. As a result, you may want to look for an opportunity to "short" Treasuries. An investor can short Treasuries through an exchange-traded fund ( ETF) that seeks to profit when such government bonds fall in value.

There are several ETFs that short Treasuries of varying maturities that include 7-10 year bonds, 20+ year bonds and others. One ETF, UltraShort Lehman 20+ Treasury ProShares (TBT), rose 28.7% in the month of January. The UltraShort nature of the fund indicates that it delivers twice the inverse of the long-term U.S. Treasury Index.

If you buy an UltraShort fund at the right time, you double your profits. If you buy at the wrong time, brace yourself for double the losses. Indeed, choosing how and when to invest in Treasuries are important decisions.

If you’d like to learn more about shorting the Treasury markets or if you have any questions about ETFs that you’d like me to answer in an upcoming ETF Talk feature, please click here .