To The Moon

Summary

• We continue to recommended allocating 30% of portfolios to long-term treasury bonds based on surveys of bond newsletter writers and clear price patterns.
• EDV has gained double the S&P 500 since the October recommendation, prompting inquiries about selling, but surveys still point to higher bond prices.
• The completion of three distinct selling waves in the bond bear market gives confidence to continue to hold EDV, extending the price target to $90.

Viktor Aheiev

On October 23rd, for the first time in 10 years, we recommended allocating 30% of one’s portfolio to long-term treasury bonds - specifically, the zero coupon ETF (NYSEARCA:EDV). The timing of the forecast was based on two pieces of data - the extreme number of bearish newsletter writers in the Hulbert bond survey and a very distinct three wave price pattern.

We forecast a 25% price rise in EDV, which we thought would occur over six to nine months. Well, the 25% advance only took two months and the gain in EDV has been double the S&P 500.

This rapid result caused a number of readers to inquire whether it's time to sell EDV now that it's achieved its price target. The answer to that question is very clear - DON'T SELL. The investment survey that prompted the original buy signal is still pointing to lower rates and higher bond prices.

We were fortunate to buy EDV at the exact bottom. That doesn't happen very often. History has taught us that when it does, one should not be too anxious to take profits, especially when there are no signal to sell. A quote from the great Jesse Livermore speaks to this situation:

Experience has taught me that the real money made in speculating has been in commitments in a stock or commodity showing a profit right from the start.

The Three Wave Campaign

This chart shows the two factors that prompted our 30% bond allocation and produced a forecast of a 25% gain. The first is the three selling waves that formed the year and a half bear market in bonds. They are clear and distinct. We've numbered them one to three.

You should always take great interest anytime you see three distinct waves like this, especially over price movements that have lasted more than a year. We were lucky to catch the exact ending of the third selling wave. We've circled with an oval the 27% price gain off this low.

Mark Hulbert has long kept a daily track record of what newsletter writers are saying about bonds. It acts as the contrary opinion indicator and his records go back to before 2000. To gain a longer term perspective, we take his daily numbers and perform a time weighted moving average on them. We then graph the moving average on the Sentiment King red-green ranking scale. A Green Zone reading - which represent when most writers are bearish on bonds - is bullish. The opposite is true for the Red Zone. (The Sentiment King)

The great trader W.D. Gann spoke of this three wave pattern in his classic work, "My 45 Years on Wall Street." He wrote:

Stock market campaigns move in 3 to 4 Sections or waves. Never consider that the market has reached final top when it makes the first section in a move up, because if it is a real Bull Market it will run at least 3 Sections, and possibly 4, before a final high is reached.

In a Bear Market, or declining market, never consider the market as final bottom when it makes the first decline or Section because it will run 3, and possibly 4 Sections before the Bear campaign is over.

The Hulbert Bond Survey Still Points to Low Interest Rates and Higher Bond Prices

But it was the second factor - the Hulbert survey of bond market newsletter writers - that gave us confidence to make the forecast and also get the timing right.

As the chart shows there were three, strong green zone readings, each one occurred at the low of each selling wave. We knew there was a risk of the third decline finishing in a selling climax but felt it was worth taking. Had it ended this way we figured the climax would quickly reverse, bringing about a profit. Lucky it didn't.

New Price Forecast For EDV

We think the October price low of $63.53 will be the low for some time, at least for a few years. The chart shows that the survey of newsletter writers is still far from a red zone reading. The current neutral reading means that, even though there's been a large price rise, newsletter writers are still cautious about rates going lower. This means they probably will, and prices will rise. This gives us his confidence to hold the position in EDV.

Remember, unlike stocks, high quality bond prices are inextricably linked with interest rates. If rates come down, bond prices have to go up. So we’re updating our price forecast for EDV from $80 to $90 - or until we get a red zone reading from the Hulbert survey.