Financial research firm Gavekal: China's government bonds perform steadily, highlighting their safe-haven value

By The Daily Economic News Reporter | Zhang Shoulin By The Daily Economic News Editor | Yang Yi

Recently, the financial research institution Gavekal released a research report, which provides a detailed analysis of the state of international reserve assets.

The report points out that since 2012, investing in Chinese government bonds has been one of the few ways to help global government bond portfolios generate returns that outperform U.S. inflation. In recent years, Chinese government bonds have performed steadily and are gradually becoming a viable alternative reserve asset, which could weaken the positions of gold and U.S. government bonds.

The research report also points out that, based on a comprehensive analysis, Chinese government bonds can be viewed as a potential reserve asset.

Gold sell-off pressure may persist

The Daily Economic News learned that the above-mentioned research report released by Gavekal was authored by Charles Gave and Louis-Vincent Gave. In the report, the two authors state that for many years, the market’s default preferred reserve asset has been U.S. government bonds, and that the bulk of the reserve holdings of central banks around the world consists of U.S. government bonds.

The research report says that as the second decade of this century gets underway, gold’s rate of return has been far ahead, and the same is true for the return on Chinese government bonds. “Gold is clearly the ultimate ‘neutral’ asset; that is to say, gold is not anyone’s liability.”

The research report also notes that since the beginning of 2002, investors should have held gold rather than U.S. government bonds, and that judgment still holds true today.

However, recently the gold price has seen large fluctuations, and the market has raised such questions—why has the gold price fallen sharply in the short term?

The simplest explanation is that gold was previously severely overbought, and overbought assets are often hit by a correction. Public data shows that over the past four years, central banks around the world have collectively purchased between one quarter and one third of global annual gold production.

The research report further analyzes that another possible explanation is that the new Federal Reserve will be more hawkish than the market expects, and the collapse of rate-cut expectations is undoubtedly one factor behind the pressure on gold over the past few weeks. Once the market stabilizes, gold can resume its upward trend. However, the recent sell-off pressure on gold may persist until overall market volatility eases.

In the above-mentioned research report, the two authors also propose a new perspective: within a framework based on the “Ayla paradox” and the “Wicksell interest rate theory,” the market assumes a binary choice between gold and U.S. government bonds, but people today are no longer living in such a binary world. For many countries, many central banks, and less dogmatic investors, Chinese government bonds are now a viable alternative choice.

Chinese government bonds’ hedging and safety appeal stands out

The research report shows that after experiencing geopolitical shocks, Chinese government bonds have performed steadily and are becoming a truly feasible alternative reserve asset.

“Since China began opening its bond market to foreign investors, we have explained the reasons for investing in Chinese government bonds multiple times.” In the research report, the two authors point out that the data itself speaks for the issue. Since 2012, investing in Chinese government bonds has been one of the few ways to help global government bond portfolios deliver returns that outperform U.S. inflation. During this period, all investors in other major bond markets incurred significant losses. For example, investing in the bond markets of Japan, Germany, and the UK even resulted in negative nominal returns. Among major peers, only Chinese government bonds outperformed U.S. inflation.

So, what “macroeconomic” reasons can explain why Chinese government bonds can be viewed as a potential reserve asset?

In response, the research report provides the following reasons: first, China firmly maintains its position as a global industrial superpower, laying an industrial foundation for renminbi assets; second, China’s advantages in global trade continue to stand out—now, except for a few regions, China is the main trade partner for most regions around the world; third, China is now a global electricity power as well, forming a long-term comparative advantage in the power sector. The electricity produced by China is more than that of any other country, and at a lower cost. Given that the “fuel” of the future is electricity, China can generate, transmit, and store power at a cost far lower than other countries—this is clearly a comparative advantage.

Cover image source: Daily Economic News media database