Eric Sprott's most recent report has generated serious ripples within financial circles due to his unique interpretation of some rather nebulous data in the latest December Treasury Bulletin. Sprott raises a major question mark as to the constituency of the "Other Investors" as defined on page 48, which in his calculations, has accounted for $510 billion of Treasuries in the first three quarters of 2009. Could this be a "phantom purchaser" that is the Federal Reserve in all but name? Or is it something far more innocuous?

The table in question can be seen below:

Zero Hedge has received numerous emails with alternative interpretations of the data touched upon by Sprott, which for the most part can be summarized as follows: the phantom purchaser are just hedge funds accumulating "risk free" securities over the year.

This is an interesting theory, and, as it can be partially validated empirically, would weaken Sprott's argument if proven true. First a word about Hedge Fund LP interest allocation.

Most hedge funds have at least two constituent investment vehicles: an onshore and an offshore domiciled fund (think Cayman Islands, Isle of Man or the Bahamas). The bulk of any given fund's capital is in the offshore domiciled entity for numerous tax purposes which we are surprised the democratic administration has not gone after yet in its quest to close every imaginable tax loophole, thus "plugging" the $10 trillion deficit onslaught (no, seriously). Onshore funds only exist to provide an investment vehicle for fund investors who fail to satisfy some of the Qualified Investor criteria permissive for an "offshore" status, or merely for any investors that specifically wish to be in an onshore vehicle. This is by and far a substantial minority of all hedge fund investors, as most LPs seek way to minimize taxes at all costs, which is why they demand their capital be allocated to offshore operations. Luckily, the fact that the bulk of hedge fund operations originates, in practice, offshore (even if the investment decisions for the bulk of capital flows ultimately come from the same few offices in New York and Greenwich) provides us with a useful way of tracking fund flows, specifically by looking at the Treasury international Capital (TIC) monthly flows.

Several unique countries in the monthly TIC report have long been considered to be broadly indicative of the action within the hedge fund community: these countries are the Channel Islands and Isle of Man, the Cayman Islands, the Bahamas, Bermuda, Netherlands Antilles, Panama, and, in some cases, the entire United Kingdom (the last is open to debate).

Zero Hedge has taken the TIC data for these hedge fund heavy regions and compiled the Treasury flow data. Again, keep in mind, offshore funds (such as those captured by the above data) account for the bulk of hedge fund activity, implying that onshore transactions represent a minority of hedge fund activity. TIC data indicates that the above group of countries (including all of the UK), was responsible for purchasing $94 billion in Treasuries (both Bills and Bonds) in the first 9 months of 2009 (incidentally October saw a major puke in USTs to the tune of $21 billion, branging the total YTD to $73 billion. Notable here is that the $94 billion is not even in the same ballpark as the $510 billion from "other investors." And even that read would be wrong: the TIC data, and what the above analysis indicates, is that the $94 billion in hedge fund purchases would actually fall in the category of "Foreign and International Buyers" meaning that only Onshore Hedge Fund vehicles could be responsible for plugging the $510 billion hole. Of course, that would mean eliminating attribution to the UK. And looking at TIC data for January thru September for the above country list and excluding the UK confirms that hedge funds are not the critical, and phantom, buyer: they only bought $13 billion through September. Add October, and hedge funds excl. the debated UK impact, and hedge funds sold a total of $15 billion in long and short-term treasuries! Hedge Funds have been net sellers of treasuries if one includes all available data.

This means that either the onshore portion of hedge funds has become a majority contributor to HF performance (extremely unlikely) or that hedge funds have been selling US Securities in their offshore funds even as they have been buying Treasuries through onshore vehicles (also highly unlikely).

This data provides preliminary evidence that Sprott is in fact right in questioning the "other investors" category: the traditional fall back of "the hedge fund made me do it", or in this case "...bought the security" just won't fly this time. We hope the US Treasury and the Federal Reserve will address Sprott's question in the near future.