First let's ensure we understand the basics of bonds.
Bonds are a form of debt. Each time a company or a government must borrow money it can borrow from banks and pay interest on the loan, or it can 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 along with the interest, so your loan gradually gets paid off. Bonds enable the borrower to only pay the interest while having the usage of the entire amount of the loan before the bond matures in 20 or 30 years (when the entire 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 purchase the offering. If demand is low they will have to pay higher yields to attract investors.
Another influence on yields is risk. Just like an unhealthy credit risk has to cover banks an increased interest rate on loans, so a company or government that's an unhealthy credit risk has to cover an increased yield on its bonds in order to entice investors to purchase them.
One factor that surveys show many investors don't understand, is that bond prices move opposite for their yields. That is, when yields rise the price or value of bonds declines, and in another direction, when yields are falling, bond prices rise.
Why is that?
Consider an investor running a 30-year bond bought several years ago when bonds were paying 6% yields. He wants to offer the bond rather than hold it to maturity. Say that yields on new bonds have fallen to 3%. Investors would obviously be willing to cover significantly more for his bond than for a fresh bond issue in order to get the higher interest rate. In order yields for new bonds decline the prices of existing bonds go up. In another direction, bonds bought when their yields are low will see their value available in the market decline if yields begin to increase, because investors will probably pay less for them than for the brand new bonds which will provide them with an increased yield.
Prices of U.S. Treasury bonds have been particularly volatile over the last three years. Demand for them as a safe haven has surged up in periods when the stock market declined, or when the Euro-zone debt crisis periodically moved back into the headlines. And demand for bonds has dropped off in periods when the stock market was in rally mode, or it appeared that the Euro-zone debt crisis had been kicked later on by new efforts to bring it under control.
Meanwhile, in the backdrop the U.S. Federal Reserve has affected bond yields and prices using its QE2 and 'operation twist' efforts to put on interest rates at historic lows.
Consequently of the frequently changing conditions and safe-haven demand, bonds have provided the maximum amount of chance for gains and losses because the stock market, or even more.
For example, just since mid-2008, bond etfs holding 20-year U.S. treasury bonds have seen four rallies in which they gained as much as 40.4%. The smallest rally produced a gain of 13.1%.
But they were not buy and hold type situations. Each lasted only from 4 to 8 months, and then your gains were completely removed in corrections by which bond prices plunged back for 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 already established demand for U.S. Treasury bonds soaring again as a safe haven.
The end result is that bond prices are again spiked around overbought levels, for instance above their 30-week moving averages, where they are at high risk again of serious correction. In fact they are already struggling, with a potential double-top forming at the long-term significant resistance level at their late 2008 high.
Here are a few reasons, along with the technical condition shown on the charts, you may anticipate an important correction in the buying price of bonds. bonds to invest in the UK
The current rally has lasted about as long as previous rallies did, even during the 2008 financial meltdown. Bond yields have reached historic low levels with hardly any room to maneuver lower. The stock market in its favorable season, and in a fresh leg up after 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 will likely bring relief by at the very least kicking the crisis down the road.
Holdings designed to maneuver opposite to the direction of bonds and therefore produce profits in bond corrections, include the ProShares Short 7-10yr bond etf, symbol TBX, and ProShares Short 20-yr bond, symbol TBF. For those attempting to take the additional risk, there are inverse bond etfs leveraged two to at least one, including ProShares UltraShort 20-yr treasuries, symbol TBT, and UltraShort 7-10 yr treasuries, symbol TBZ, designed to maneuver doubly much in the contrary direction to bonds. And even triple-leveraged inverse etf's like the Direxion 20+-yr treasury Bear 3x etf, symbol TMV, and Direxion Daily 7-10 Treasury Bear 3X, symbol TYO.
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