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 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 that the bank will most likely require payments on the principle of the loan in addition to the interest, so that the loan gradually gets paid off. Bonds enable the borrower to only pay the interest whilst having the utilization of the whole amount of the loan until the bond matures in 20 or 30 years (when the whole amount should 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 get the offering. If demand is low they must pay higher yields to attract investors.
The other influence on yields is risk. Just like a poor credit risk has to cover banks an increased interest rate on loans, so an organization or government that's a poor credit risk has to cover an increased yield on its bonds in order to entice investors to get them.
A factor that surveys show many investors do not understand, is that bond prices move opposite for their yields. That is, when yields rise the cost or value of bonds declines, and in the other direction, when yields are falling, bond prices rise.
Exactly why is that?
Consider an investor having a 30-year bond bought several years back when bonds were paying 6% yields. He wants to market the bond rather than hold it to maturity. Claim that yields on new bonds have fallen to 3%. Investors would obviously be willing to cover much more for his bond than for a brand new bond issue in order to get the higher interest rate. So as 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 will pay less for them than for the newest bonds that will give them an increased yield.
Prices of U.S. Treasury bonds have already been particularly volatile over 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 create 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 keep interest rates at historic lows.
As a result of the frequently changing conditions and safe-haven demand, bonds have provided just as much chance for gains and losses whilst the stock market, if not more.
As an example, just since mid-2008, bond etfs holding 20-year U.S. treasury bonds have experienced four rallies in which they gained as much as 40.4%. The tiniest 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 a gains were completely taken away in corrections by which bond prices plunged back for their previous lows.
Most recently, the decline in the stock market during the summer months, accompanied by the re-appearance of the Euro-zone debt crisis, has received 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 example above their 30-week moving averages, where they are at high risk again of serious correction. Actually they are already struggling, with a possible double-top forming at the long-term significant resistance level at their late 2008 high.
Here are a few reasons, in addition to the technical condition shown on the charts, you may anticipate an important correction in the price of bonds. premium bonds to invest
The existing rally has lasted about so long as previous rallies did, even during the 2008 financial meltdown. Bond yields are at historic low levels with hardly any room to move lower. The stock market in its favorable season, and in a brand new leg up after its significant summer correction. Unprecedented efforts are underway in Europe to create 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 least kicking the crisis down the road.
Holdings designed to move opposite to the direction of bonds and therefore produce profits in bond corrections, range from the ProShares Short 7-10yr bond etf, symbol TBX, and ProShares Short 20-yr bond, symbol TBF. For those attempting to take the excess 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 move twice as much in the contrary direction to bonds. And even triple-leveraged inverse etf's such as the Direxion 20+-yr treasury Bear 3x etf, symbol TMV, and Direxion Daily 7-10 Treasury Bear 3X, symbol TYO.
