Sunday, January 11, 2009

Technical Analysis of TLT

We could very well be witnessing the bursting of the US government bond bubble. Here is a chart of TLT, the iShares 20+ year treasury ETF, from 2002-2009:


One look at the chart shows that the current run up in prices is unprecedented. What you had was a trading channel for roughly a year followed by a fast breakout to the upside. When I looked at the chart I noticed that there was another case of a quick breakout in prices following a trading channel: 2002-2003. Let's zoom in on that time period:


In the second half of 2002 and the first half of 2003, TLT traded in a range from $85 to $91. On May 12, 2003 it broke out of that range. TLT hit it's high on June 9, 2003 - about 1 month later - at $97.18. This was a breakout of 7.31% from the top of the previous range. Following that peak, TLT bottomed on August 11, 2003 - about 2 months later - at $82. This was a breakdown of 3.53% below the bottom of the prior trading range. Indeed, what happened is that a breakout led to an overshoot to the upside, which caused a crash and an overshoot to the downside.

Now let's look at the current period:


From the beginning of 2008 to November 2008, TLT traded in a range from $89 to $97. On November 17, 2008 it broke out of that range. TLT hit it's high on December 15, 2008 - about 1 month later - at $122.26. This was a breakout of 25.52% from the top of the previous range. This was a breakout and an overshoot to the upside.

Now, if December 15, 2008 was indeed the peak, the fall coming in TLT is going to be enormous. If we breakdown and overshoot to the downside, TLT is in for a world of hurt. Based on the 2002-2003 scenario, this would portend a bottom in TLT on February 15, 2009 at a price of $83.74. This is a drop of 25.72% from current levels and a total drop from the peak of 31.5%.

Now, nobody knows what is going to happen here. With that being said, the charts look quite grim. If this scenario plays out, all those people that fled equities in the last few months for the "safety" of government bonds are going to get killed. My advice is to get out of government bonds until things settle back down. If you are an aggressive investor, the setup for shorting TLT has never looked better.

Note: Please see my updated posting on TLT and long term treasury bonds: Treasury Bond Market Update.

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