Why the Japanese Economy Matters for Gold

It’s been battered and bruised since early June. But, finally, gold punters have something to celebrate about. The yellow metal is trading around two-week highs at US$1,234 per ounce.

US Federal Reserve Chair Janet Yellen’s written testimony last week changed the story. She wrote to Congress: ‘Of course, considerable uncertainty always attends the economic outlook. There is, for example, uncertainty about when — and how much — inflation will respond to tightening resource utilisation.

Yellen’s certainly changed her tune…again. I thought everything was great and the economy was booming. The market obviously thought the same. That’s because gold bounced. Remember, the yellow metal is a hedge against political uncertainty.

It’s looking good for gold punters in the short term…

Last week, the US inflation number was the lowest since Donald Trump won the White House in November last year. Consumer prices rose 1.6% in July from a year earlier. US retail sales also fell for the second consecutive month. Both reports aided the gold price recovery. In my view, the Fed won’t be raising rates anytime soon.

That’s good news for the Japanese yen. The yen is trading at its strongest level since 3 July. That’s worth noting. If you didn’t know, the Japanese yen is the best indicator for the gold price. That’s why you should pay attention to the Japanese economy.

Understanding the Japanese economy

Bullion Vault reported HSBC’s latest view on 14 July:

“While yields on US and Eurozone debt have been rallying as [their] respective central banks turn attention to unwinding monetary stimulus,” says Jonathan Butler at Japanese [conglomerate] Mitsubishi, “the yield on 10-year Japanese government bonds [JGBs] has remained close to zero.

“This is no accident — in fact it is a direct result of the Bank of Japan’s policy of ‘yield curve targeting’ whereby QE [money creation and bond buying] is dialed up and down as needed in order to keep the yield around the 0% mark” on the 10-year JGB, with the aim of boosting corporate borrowing and investment.

“All other things being equal,” Butler concludes, “if Japanese yields remain low while US yields are rising, the Yen will lose ground to the Dollar and Yen-denominated precious metals prices will rise.

“This brings the risk of profit taking by physical investors in the Japanese large bar market.”

Butler makes a great point. US bond yields have shot up, with the Fed raising interest rates. That makes the country less attractive for borrowing money. Japanese bond yields, on the other hand, have stayed at near record lows. There are major concerns around inflation growth. That has kept interest rates low, which has appealed to international borrowers.

You can borrow money for 10 years at 0.07% (plus the bank’s margin) in Japan. If you make 1%, you’re on top. Now, most punters aren’t borrowing yen to make 1%. They are looking at making bigger gains. And that’s happening, thanks to cheap money. Take a look at the Nikkei 225:

Nikkei 225

Source: Google Finance
[Click to enlarge]

Japanese stocks are trading at near two-year highs.

Will the run continue?


Digging deeper

The Bank of Japan meets tomorrow. The market expects nothing new. Interest rates are likely to stay low, which should send more money into the domestic stock market. That said, while inflation growth has been slow, if it continues to improve, the BOJ will remain positive. In other words, expect the central bank to be optimistic about the country’s economic outlook.

Of course, take their words with a grain of salt…

The Japanese economy has experienced deflation for nearly four decades. The government and central bankers are to blame. Since 1990, Japanese leaders have continued with the same old policy. The focus remains on making empty promises…hoping things will turn around.

The government needs to re-structure its economy. That’s been ignored. The central bank should move towards higher interest rates, rather than punishing savers with low rates.

Mark my words: The Japanese economy will face a major financial crisis by 2020. It will be far worse than the 1990 real estate bubble popping. In my view, the Japanese central bank will try to control it by printing trillions more yen. However, as the confidence in government collapses, that will likely trigger massive hyperinflation during the next crisis.

The Bank of Japan owns more than 90% of the country’s government bonds. So, when rates start to turn around, it’s likely to lose trillions of dollars as inflation skyrockets. That’s when it will probably need to refinance and stabilise the system. That will need to happen at higher interest rates, where the debt load would skyrocket, which would likely collapse the economy.

When Japan’s financial crisis takes place, I expect the yen will skyrocket to 200 against the US dollar. That means it will cost 200 yen to buy one US dollar. It’s trading at 112 today. That’s why you should focus on the yen. Its relationship with gold is strong:


Source: Federal Reserve Bank of St. Louis
[Click to enlarge]

The red line shows the USD.JPY FX rate. The blue line shows the US dollar gold price. Gold’s relationship with the Japanese yen has reached its strongest level since mid-June. The yen shows a daily correlation with gold of 95%. In other words, 95% of the yen’s move affects gold today.

That relationship has averaged 30% over the past 20 years. And has averaged 85% this year. And while that could change, the above chart shows the correlation has been strong since 2013.

A higher yen hasn’t been good news for the gold price over that time.

If the yen skyrockets to 200 against the US dollar, it could imply that a massive gold crash looms.

I’d tread extremely carefully with your gold stocks today. We will, of course, see many more rallies in the months ahead. That could give the implication that gold’s back in favour. However, with the world facing a major financial crisis, caution remains.


Jason Stevenson,
Editor, Markets & Money

PS: My view is clear: The best investment opportunities remain outside the gold sector today. So, unless you’re investing with a strategic and long-term mindset, look outside the gold sector. To find out three of my favourite resource companies which could skyrocket at any day now, go here.

Jason Stevenson is Markets & Money’s resource analyst. He shares over a decade’s worth of investing and trading experience across resource stocks and commodity futures and options. He originally studied accounting and finance at Curtin University, where he was awarded a first-class honours degree. His professional background stems across high-net-worth, top tier accounting (corporate finance, tax and auditing), and sell-side equities research. Before joining the team at Markets and Money, Jason worked at boutique firms which advised fund managers and high-net-worth clients on where to invest. Whether it’s gold, crude oil, copper or an obscure metal like vanadium, you can rely on an in-depth analysis in Markets and Money. Jason also brings you extensive macro, political and geopolitical analysis from around the world. He leaves no stone unturned when it comes to telling the truth. Jason is also the lead analyst of Gold Stock Trader, a premium service for investors serious about precious metal stocks. Websites and financial e-letters Jason writes for:

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