donderdag 6 november 2014

Correlation: Will Japan be able to keep gold steady in JPY in 2015?

Japan has upped the speed of money printing starting in 2013, just at the same time the U.S. did QE3. This has actually been keeping the USD and JPY exchange rate stable. But now when Japan announced QE infinity with triple the size of U.S. QE compared to their GDP, that stable exchange rate will start to deteriorate. Be aware that one must not look at the absolute size of QE, but needs to look at QE as a percentage of GDP. When a low GDP country prints the same amount of money as a large GDP country, its currency will depreciate much faster than the currency of the larger GDP country.

Another pretty stable exchange rate was gold compared to JPY. Since 2013 the gold price hasn't done anything against the JPY. This means all of the printed money went into Japanese stocks instead of gold. I think the central banks have perfectly orchestrated it.

But what will happen when we have this regime change now? I think the gold price will definitively increase in Japanese JPY, that will be inevitable with this size of QE.

It will be interesting to watch what the U.S. will do next when they see all this deflation coming their way.

What's even more interesting is that the Japan yen carry trade is so obvious now.

They borrow yen to use those yen to buy equities and short gold. The graph above shows this correlation between USD/JPY and gold, which I will add to our list of correlations. I suspect Japan wants to hold gold steady to show all is well and that there is no inflation. This carry trade cannot keep going on forever as it will blow up at some point. Physical supply and demand will eventually be the most logical conclusion. And the yen carry trade will only end when borrowing costs start to rise due to an increase in interest rates. So watch out for the rise in yields, which will prick the carry trade bubble. Another scenario could be that the Japanese debt is so unsustainable that we get a Greece situation where bond yields start to spike. And finally the ultimate scenario will be that the yield on the carry traded yen equals the yield on the U.S dollar, that's the scenario where carry trading doesn't work anymore as you need to have a difference in yield between the two currencies. We are already seeing this has happened in Germany, where yields are the same as in Japan. Which means no carry trade is possible for euro yen based on yield spread. And I'm pretty sure U.S. bond yields will be coming down as GDP growth slows down, so U.S. bond yields will be converging to Japanese bond yields as well, and that will be the end of it.

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