First let's make certain we understand the basics of bonds.
Bonds are a form of debt. Each time 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 the loan gradually gets paid off. Bonds allow the borrower to only pay the interest whilst having the utilization of the whole amount of the loan before 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 won't have to pay as high a yield to entice enough investors to get the offering. If demand is low they must pay higher yields to attract investors.
Another influence on yields is risk. Just as a poor credit risk has to pay banks an increased interest rate on loans, so a business or government that is a poor credit risk has to pay an increased yield on its bonds to be able to entice investors to get them.
An issue that surveys show many investors don't understand, is that bond prices move opposite with 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.
How come 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 rather than hold it to maturity. Say that yields on new bonds have fallen to 3%. Investors would obviously be willing to pay considerably more for his bond than for a fresh bond issue to be able to get the higher interest rate. So as yields for new bonds decline the prices of existing bonds go up. In another 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 which will provide them with an increased yield.
Prices of U.S. Treasury bonds have now been particularly volatile throughout 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 in 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 have been kicked down the road by new efforts to bring it under control.
Meanwhile, in the background the U.S. Federal Reserve has affected bond yields and prices having its QE2 and 'operation twist' efforts to put up interest rates at historic lows.
Consequently of the frequently changing conditions and safe-haven demand, bonds have provided just as much opportunity 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 littlest rally produced a gain of 13.1%.
But these 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 by which bond prices plunged back with their previous lows.
Most recently, the decline in the stock market during the summertime months, followed 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 up to overbought levels, as an example 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, in addition to the technical condition shown on the charts, you may anticipate an important correction in the buying price of bonds.
The current rally has lasted about provided that previous rallies did, even during the 2008 financial meltdown. Bond yields have reached historic low levels with hardly any room to go 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 probably bring relief by at the least kicking the crisis down the road. invest bonds UK
Holdings designed to go 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 wanting to take the additional 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 go doubly much in the alternative 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.
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