First let's ensure we understand the basic principles of bonds.
Bonds are an application of debt. When a company or even a government needs to borrow money it may borrow from banks and pay interest on the loan, or it may borrow from investors by issuing bonds and paying interest on the bonds.
One benefit of bonds to the borrower is a bank will usually require payments on the principle of the loan as well as the interest, so the loan gradually gets paid off. Bonds permit the borrower to only pay the interest whilst having the utilization of the whole level of the loan until the bond matures in 20 or 30 years (when the whole amount must be returned at maturity).
Two main factors determine the interest rate the bonds will yield.
If demand for the bonds is high, issuers will not have to cover as high a yield to entice enough investors to buy the offering. If demand is low they will need to pay higher yields to attract investors.
The other influence on yields is risk. Just as an unhealthy credit risk has to cover banks a higher interest rate on loans, so a company or government that's an unhealthy credit risk has to cover a higher yield on its bonds to be able to entice investors to buy them.
An issue that surveys show many investors don't understand, is that bond prices move opposite with their yields. That's, when yields rise the price or value of bonds declines, and in the other direction, when yields are falling, bond prices rise.
How come that?
Consider an investor owning a 30-year bond bought several years back when bonds were paying 6% yields. He wants to market the bond as opposed to hold it to maturity. Claim that yields on new bonds have fallen to 3%. Investors would obviously be willing to cover somewhat more for his bond than for a new bond issue to be able to get the larger interest rate. Whilst yields for new bonds decline the values of existing bonds go up. In the other direction, bonds bought when their yields are low might find their value available in the market decline if yields begin to rise, because investors can pay less for them than for the newest bonds that will let them have a higher yield.
Prices of U.S. Treasury bonds have been particularly volatile throughout the last three years. Demand for them as a secure haven has surged up in periods once the stock market declined, or once the Euro-zone debt crisis periodically moved back to the headlines. And demand for bonds has dropped off in periods once the stock market was in rally mode, or it appeared that the Euro-zone debt crisis have been kicked in the future by new efforts to bring it under control.
Meanwhile, in the back ground the U.S. Federal Reserve has affected bond yields and prices using its QE2 and 'operation twist' efforts to keep interest rates at historic lows.
Consequently of the frequently changing conditions and safe-haven demand, bonds have provided as much opportunity for gains and losses because the stock market, if not more.
For example, just since mid-2008, bond etfs holding 20-year U.S. treasury bonds have experienced four rallies in that they gained as much as 40.4%. The littlest rally produced a gain of 13.1%.
But they certainly were not buy and hold type situations. Each lasted only from 4 to 8 months, and then your gains were completely taken away in corrections where bond prices plunged back with their previous lows.
Of late, the decline in the stock market during the summer months, followed closely by the re-appearance of the Euro-zone debt crisis, has received demand for U.S. Treasury bonds soaring again as a secure haven.
The result is that bond costs are again spiked as much as overbought levels, for instance above their 30-week moving averages, where they are at high risk again of serious correction. In reality they are already struggling, with a possible double-top forming at the long-term significant resistance level at their late 2008 high.
Here are some reasons, as well as the technical condition shown on the charts, to expect an important correction in the buying price of bonds.
The existing rally has lasted about so long as previous rallies did, even through the 2008 financial meltdown. Bond yields are at historic low levels with hardly any room to maneuver lower. The stock market in its favorable season, and in a new leg up as a result of its significant summer correction. Unprecedented efforts are underway in Europe to bring the Euro-zone debt crisis under control. And this week those efforts were joined by supportive coordinated efforts by major global central banks that are likely to bring relief by at least kicking the crisis down the road. premium bonds to invest in the UK
Holdings designed to maneuver opposite to the direction of bonds and therefore produce profits in bond corrections, are the ProShares Short 7-10yr bond etf, symbol TBX, and ProShares Short 20-yr bond, symbol TBF. For those wanting to take the excess risk, there are inverse bond etfs leveraged two to one, including ProShares UltraShort 20-yr treasuries, symbol TBT, and UltraShort 7-10 yr treasuries, symbol TBZ, designed to maneuver doubly much in the opposite direction to bonds. And even triple-leveraged inverse etf's including the Direxion 20+-yr treasury Bear 3x etf, symbol TMV, and Direxion Daily 7-10 Treasury Bear 3X, symbol TYO.
