First let's make sure we understand the basics of bonds.
Bonds are a questionnaire of debt. When a company or even a government needs to borrow money it could borrow from banks and pay interest on the loan, or it could 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 in addition to the interest, so the loan gradually gets paid off. Bonds enable the borrower to only pay the interest whilst having the utilization of the entire level of the loan before bond matures in 20 or 30 years (when the entire 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 pay for as high a yield to entice enough investors to buy the offering. If demand is low they will have to pay higher yields to attract investors.
The other influence on yields is risk. Just like an undesirable credit risk has to pay for banks an increased interest rate on loans, so a business or government that's an undesirable credit risk has to pay for an increased yield on its bonds in order to entice investors to buy them. invest bonds
An issue that surveys show many investors don't understand, is that bond prices move opposite for their yields. That is, when yields rise the purchase price or value of bonds declines, and in another direction, when yields are falling, bond prices rise.
Why is that?
Consider an investor owning a 30-year bond bought several years back when bonds were paying 6% yields. He wants to sell 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 for considerably more for his bond than for a new bond issue in order to get the higher interest rate. In order 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 available in the market decline if yields begin to go up, because investors will probably pay less for them than for the newest bonds which will let them have 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 when the stock market declined, or when the Euro-zone debt crisis periodically moved back to 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 down the road by new efforts to create it under control.
Meanwhile, in the backdrop the U.S. Federal Reserve has affected bond yields and prices having 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 as much chance for gains and losses while 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 that 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 recinded in corrections where bond prices plunged back for 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 effect is that bond prices are again spiked as much as 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.
Below are a few reasons, in addition to the technical condition shown on the charts, to expect a substantial correction in the buying price of bonds.
The present rally has lasted about so long as previous rallies did, even throughout the 2008 financial meltdown. Bond yields are at historic low levels with almost no room to maneuver lower. The stock market in its favorable season, and in a 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 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 anyone planning to take the additional risk, you will 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 maneuver two times as 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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