Investing in 2024 has proven to be a formidable challenge, yet two particular avenues have offered investors remarkable returns amidst a climate of uncertainty.

Firstly, gold has seen a tremendous surge, surpassing $2,400 per ounce—a new historical high that has captivated the market's attentionInvestors are flocking to this safe-haven asset, prompting discussions about the long-term value of precious metals as insurance against economic instability.

Secondly, the bond market has presented itself as a viable investment choice, particularly for everyday investors who may not engage directly with the secondary bond marketInstead, they have benefited from financial products and bond funds that focus heavily on bonds as their underlying assetsHowever, this initial success has not remained untouched by recent trends.

Since August 2024, the landscape has shifted dramatically for both financial products and bond funds, with daily net values declining to various degrees, leading many to experience more losses than gains.

What's behind this reversal? Who is responsible for this dip in performance? And why can't bond prices continue to rise indefinitely? To understand the situation, it's essential to delve into the mechanics of a bull market in bonds.

Bonds come in various forms, including government bonds, municipal bonds, bank bonds, and corporate bonds

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Among these, government bonds stand out as the largest and most scrutinized by the marketObserving the price trends of ten-year government bond futures reveals a steady rise.

Since October of the previous year, bond prices have climbed from 101.19 to 106.55, translating to a 5.3% increase over ten months, equating to an annual yield of approximately 6.4%.

This 6.4% annual yield figures prominently in discussions surrounding government bonds, contrasting starkly with stock prices that can veer wildlyUnlike stocks, bonds are compared to low-risk, low-yield instruments such as fixed-term depositsRecent interest rate cuts on bank deposits have seen major banks drop their five-year deposit rates below 2%, with the highest yields on three-year large-denomination certificates of deposit hovering around 2.15%. Smaller banks may offer marginally better rates, but rarely hit 3%.

This comparison sheds light on the powerful allure of "bond bulls." The higher yields prompt masses of household savings to shift from traditional savings accounts and certificates toward financial products and bond funds.

As more individuals purchase these bonds, prices are pushed higher, creating a self-reinforcing cycle that leads to further demand and skyrocketing prices.

However, the situation isn't solely about retail investors; financial institutions, particularly regional banks, have also been scrambling to acquire bonds.

For banks, deposits represent liabilities

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Upon maturity, they must return principal along with interest to depositorsTo counterbalance these expenses, banks seek various interest-earning assets, with loans being the primary avenueBy loaning money—be it personal mortgages or business loans—they can earn interest income.

Yet, recent years have posed a different picture, as home buying has declined, and many individuals are even opting to pay off their mortgages early, leading to decreased housing loan activityConcurrently, businesses have been hesitant to borrow for investments, resulting in a further decline in operational loansThis reduction in income-generating assets poses a dilemma, as liabilities (deposits) remain high, compelling banks to turn to bonds as substitute assets.

As long as bond prices keep rising, all parties remain contentHowever, as recent events illustrate even within the booming real estate market, the notion of continued price ascension is fraught with peril; prolonged increases can result in bubbles which inevitably burst.

In the event of such a burst, smaller banks that purchased bonds at elevated prices may face dire repercussions, given their already less robust risk management strategies compared to larger banks, consequently leading to potential insolvency.

The role of banks within China's financial ecosystem cannot be overstated; a disturbance in one regional bank could spiral into a broader crisis, affecting the financial fabric on a larger scale.

Some readers may perceive this as alarmist, questioning how banks could collapse—especially since these institutions are merely increasing their holdings of government bonds rather than engaging in high-risk financial activities like investing in stocks or futures.

It is indeed plausible

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Take, for example, the recent collapse of Silicon Valley Bank in the United States, which stemmed from its substantial investment in Treasuries at elevated pricesAs the Federal Reserve raised interest rates, the market value of existing bonds plummeted, resulting in severe paper losses for the bank, ultimately leading to its liquidation.

Without preventive measures, several smaller banks in China could follow in the footsteps of Silicon Valley Bank.

Recognizing the emerging threats, the central bank has reacted decisively, implementing stringent measures aimed at reigning in the tumultuous bond market.

The central bank has proactively indicated the risks inherent in the current climate, stating intentions to conduct reverse repos to offload government bonds, an effort to temper the fervor surrounding bond investmentsWhile concrete actions have yet to be taken, the continuous communication of these intentions serves a precise purpose—discouraging smaller financial institutions that have been voraciously acquiring bonds.

However, while this act of preemptively addressing risk is commendable, it does little to alleviate the banks' ongoing dilemma of asset scarcity

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If they aren't buying bonds, what alternatives do they have?

The central bank could stimulate corporate investment through an accommodating monetary policy, but this approach's effectiveness remains in questionThe Japanese central bank, for instance, has sustained low or even zero interest rates for years yet has seen its economy meander through a period referred to as the "lost 30 years," reinforcing the idea that central banks possess limited control over several economic dynamics.

The willingness of individuals and enterprises to borrow generally hinges on the availability of promising investment opportunities with high returnsFor instance, during a real estate boom, banks find no shortage of borrowers seeking loans, regardless of the interest ratesSimilarly, when the economy experiences robust nominal growth, corporations are eager to expand and will seek loans to capitalize on favorable financing conditions.

Consequently, the central bank's decision to hit the brakes on the bond market is justifiable; preventative measures against systemic financial risks must remain a top priority.

However, once the momentum halts, the crucial question arises: in which direction should economic activity be steered? The central bank has yet to provide guidance here, indicating that it's the responsibility of various market entities to chart the course forward.