First let's make certain we understand the basics of bonds.
Bonds are a questionnaire of debt. When 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 advantage of bonds to the borrower is that a bank will usually require payments on the principle of the loan as well as the interest, so your loan gradually gets paid off. Bonds allow the borrower to only pay the interest while having the utilization of the entire level of the loan until 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 won't have to pay as high a yield to entice enough investors to get the offering. If demand is low they will have to pay higher yields to attract investors.
The other influence on yields is risk. In the same way a poor credit risk has to pay banks an increased interest rate on loans, so an organization or government that is a poor credit risk has to pay an increased yield on its bonds in order to entice investors to get them.
An issue that surveys show many investors do not understand, is that bond prices move opposite with their yields. That's, when yields rise the cost 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 back when bonds were paying 6% yields. He wants to offer the bond as opposed to hold it to maturity. Say that yields on new bonds have fallen to 3%. Investors would obviously be willing to pay far more for his bond than for a new bond issue in order to get the larger interest rate. So as yields for new bonds decline the values of existing bonds go up. In another direction, bonds bought when their yields are low might find their value on the market decline if yields begin to go up, because investors will pay less for them than for the brand new bonds that may provide them with an increased yield.
Prices of U.S. Treasury bonds have now been particularly volatile during the last three years. Demand for them as a safe haven has surged up in periods once the stock market declined, or once the Euro-zone debt crisis periodically moved back into 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 had been kicked later on by new efforts to bring it under control.
Meanwhile, in the back ground the U.S. Federal Reserve has affected bond yields and prices with its QE2 and 'operation twist' efforts to keep interest rates at historic lows.
As a result of the frequently changing conditions and safe-haven demand, bonds have provided just as much opportunity for gains and losses while the stock market, or even more.
As an example, just since mid-2008, bond etfs holding 20-year U.S. treasury bonds have noticed four rallies in which they gained around 40.4%. The littlest 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 the gains were completely taken away in corrections in which bond prices plunged back with their previous lows.
Lately, the decline in the stock market during summer time months, accompanied by the re-appearance of the Euro-zone debt crisis, has had demand for U.S. Treasury bonds soaring again as a safe haven.
The result is that bond costs are again spiked around overbought levels, for example above their 30-week moving averages, where they're at high risk again of serious correction. In reality they're already struggling, with a potential double-top forming at the long-term significant resistance level at their late 2008 high. invest bonds UK
Here are a few reasons, as well as the technical condition shown on the charts, you may anticipate an important correction in the price tag on bonds.
The current rally has lasted about so long as previous rallies did, even through the 2008 financial meltdown. Bond yields are in historic low levels with very little room to move 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 the least kicking the crisis down the road.
Holdings designed to move 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 anyone attempting to take the extra risk, you can find inverse bond etfs leveraged two to 1, including ProShares UltraShort 20-yr treasuries, symbol TBT, and UltraShort 7-10 yr treasuries, symbol TBZ, designed to move twice as much in the opposite 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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