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TBT Baby- Update

I got lots of positive feedback on my TBT idea, so I know there's a bunch of you who are very happy watching this one run up the charts as the rest of the market is getting whacked into oblivion right now.

In case you need a reminder, TBT is the ETF I recommended below $40 back on January 3rd. Today, TBT closed at $44.72. Net profit- 14.6% if you paid cash, 30% if you bought on margin. The March 40 calls I recommended at $4 have also appreciated nicely. I closed out my position in those calls for a 50% profit, and kept the ETF I own at $40.

TBT is the ETF that trades as an inverse of the US Treasury Long Bond. As with all bonds, when the price goes up, the yield or interest rate goes down, and vice versa. Back in November and December there was, in my view, an irrational flight to the perceived safe haven of the US Treasury 20 year bond. As the buying came in, the price went up, and the yield went down. So low in fact, the yield went to 2.5%, which is absolutely absurd for such a long term debt instrument. The US Treasury Long Bond hasn't traded to 2.5% since 1952.

This irrational fear bubble as measured by the yield was bound to burst, and it has started. You can see TBT stair stepping up the charts. Now that I've watched it for several weeks, it's becoming easier to forecast where it might end up.

When the Long Bond traded to a 2.5% yield, TBT traded to $36. Today, the closing yield in the Long Bond was 3.31. That's a 32% increase in yield. At the same time, the price of TBT has increased 24.2%. TBT gets about 75% of the yield change. 

If one assumes the Long Bond will go back to about the 4% level, there's a 20% move left, which would equate to a 15% move in TBT. $51.30 now becomes the price target for this idea.

Also, if you like Fibonacci Retracements as I do, now is not the time to establish a new position in TBT. Look for $41.20 if it pulls back there.

Is It Time For the Financials To Rally?

Blown up, beat up, decimated, killed, mashed, irrationally bashed, murdered. Any one of these adjectives describes the way the market is treating the financial sector right now.

So, what's the story behind the story? Are the banks really on the verge of going under? Or is this more irrational pessimism. I believe the financials will rally, and the way to figure out when is to watch the value of AAA mortgage portfolios.

I don't have the most current chart because it's hard to get, but here's one from last week. I know it's a little hard to see, but the chart tells us that investment grade mortgage portfolios are only finding a bid of $.36 on the dollar. 

Consider the implications. First, if you are a bank with a bunch of TARP money, why would you go out and originate new mortgage loans when you can buy perfectly good ones at $.36 on the dollar? Say those loans were originated at 6%- today they yield about 16%. So, if you're a bank, and you can buy investment grade mortgage portfolios yielding 16%, why would you originate any loans at 6%?

As you can tell from this chart, there really isn't a good market for these mortgage portfolios. But, what happens when these value of these mortgage portfolios starts to improve? Glad you asked. These portfolios are marked to the market, forcing the banks to take huge write downs. They have assets on their books improperly valued.

When the bid starts to come back, the banks will get to write up these values, and have big funny money gains the same way they are experiencing big funny money losses.

It's tough to say how long it will take. The market believed the original version of the TARP would put a floor on these mortgage pools. However, Paulson changed his position, and rather than using the money to buy mortgages, he just decided to write checks to the banks at the peril of a furious bunch of Congressmen. 

I was in favor of using US Treasury money to buy mortgages for pennies on the dollar. I felt it would be a good investment on behalf of the taxpayers, and give the banks the option of converting those loans to cash. When the money just went straight to the banks, the bid for mortgages went away, and the S&P went right down with it, along with my belief that the government had any idea what it was doing.

I believe the financials are oversold and ready for a bounce. Instead of looking at any one particular financial institution, consider the ETF that reflects the financials. XLF made a new all time low these week and blew everyone's brains out who was long. This big downdrafts can be great trading opportunities.

I like XLF at $9 for a bounce to the $11 range in short order. Set your stop at $8.50. These news lows that kill everyone are great opportunities to go long for a trade. 

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