"I would be very interested in your views on the purchase of the 30 year German Bund in the attached Aubrey Collective Conviction Fund portfolio."

Eoin Treacy's view Thank you for this interesting issue of the fund's report. Here is the section you are referring to:

The story is a disarmingly simple one and benefits from an asymmetrical outcome to the problems we currently see facing the Euro project. If, as many believe, the Greeks leave the Euro or the Eurozone splits into two halves (North and South), the holder of a German bond will be in effect a holder of Deutschmarks, arguably the most attractive and undervalued currency in the world. Or alternatively the Euro holds together and a deflation is unleashed across Euro land as the PIIGS seek to undercut German competitiveness and growth across the region is muted. In such a scenario the current 4% yield could easily fall to say 2% as happened in Japan, giving a 50% rise in the capital value of our bond. While awaiting either eventuality, investors can enjoy an annual yield of around 4% paid to sterling investors in Euros.

The majority of the Fund's portfolio leans in the direction of inflation trades whether this is equities, index linked bonds, Gold or commodities. To have five per cent invested in a deflationary asset does not to us seem a contradiction, we might for instance be wrong about inflation or perhaps the great inflation/ deflation debate is not quite as black and white as the protagonists on either side make out, why not inflation in the US and China say and deflation in Europe? After all, Japan managed it, oblivious to what the rest of the world was doing for the past twenty years.

30yr Euro Bund yields continues to trend lower having hit a medium-term peak in June 2009 and would need to sustain a move above 4% to break the progression of lower highs and question the downtrend. However while German bonds are almost certainly the most secure in Europe, the Bundesbank has a sound record for fighting inflation and Germans have a high regard for fiscal responsibility, there remains a strong likelihhod that yields bottomed in 2008 near 3%.

Worries surrounding Greece in particular has increased demand for German and Northern Continental European debt but I wonder to what extent this will continue as the effective risk of a Greek default is discounted as the recent support package is implemented. I agree that 30yr German bonds offer a hedge against some rather extreme potential outcomes but could underperform if the Euro experiment continues to muddle along which I suspect is the most probable outcome.

An additional aspect to the investment is the relative strength of the Pound to the Euro. The Pound hit at least a medium-term low against the Euro in January 2009 and continues to post a progression of higher reaction lows. Sentiment towards the UK economy remains extraordinarily bearish, but the currency would need to sustain a move below €1.095 to begin to indicate a return to Euro ascendency and the resumption of base formation development at somewhat lower levels.