Yen amp Gold Sink in Sync

The combination of:
i) rampant monetary easing;
ii) passive currency depreciations and;
iii) disinflationary economic data and;
iv) soaring equities has produced the perfect storm against both gold and the Japanese yen.

Monetary easing escalates courtesy of the ECB’s willingness to slash deposit rates below zero (dragging the deposit-lending spread to a five-year low of 1.00%), the Reserve Bank of Australia’s 25-bp rate cut in its cash rate to 50-year lows, the Bank of Korea’s 25-bp cut in its base rate to three-year lows and the Federal Reserve’s willingness to increase asset purchases.

Currency easing – aka currency depreciations are going beyond the usual practice of aggressive monetary easing (Fed, BoJ, ECB’s hint at negative rates) and onto actual intervention (RBNZ’s actual selling of its own currency). Whether currency depreciation is direct or indirect by central banks, the final product remains the same. And with the US dollar being the only currency to have risen against G10 currencies gaining year-to-date, we may expect further dovishness from the central bank with regards to keeping QE unchanged or even raising it.

The Bank of Canada may have been the exception in avoiding asset purchases, but last week’s appointment of the head of Canada’s export agency at the helm of the Bank of Canada means that Canadian exporters will finally find an ally at the central bank. Stephen Poloz is likely to be more attentive to the needs of exporters via capping the Canadian dollar, which was not the case with Marc Carney.

Data Weakness– 33-month lows in Eurozone inflation, the threat of a double dip in German growth, disappointing US ISM surveys and mixed data from China have cemented the notion that inflation is nowhere to be found on the list of central banks’ priorities. Eroding signs of inflation have been instrumental in triggering the recent damage in gold. Regardless of the intensity of current and planned QE programs from central banks, as long as asset purchases are not transmitted out of central banks and organic growth is fading, the risk becomes that of disinflation and not inflation.

Equities– It is easier for asset purchases to boost asset prices than the real economy. The widening disconnect between market metrics and macroeconomic data may be justified through the wealth effect argument. But as we have seen in Winter-Spring 2007, equities lagged behind the economy, rather the inverse. And unlike in 2007, today’s market dynamics lack the anomalies of debt-fuelled real-estate markets and sky-high commodities prices.  And even if 92% of shares in the S&P500 trade above their 200-day moving average, this remains well below the 96-97% highs seen in 2009 and 2011.

Things change
A few hedge fund managers claim the “sell-yen” momentum trade is being used by hedge funds’ to absorb losses in last month’s gold damage. We see this differently. The yield-searching Mrs. Watanabe is gradually shifting from “sell-yen/buy gold” to “sell-yen/buy global equities/buy US treasuries”. As Japanese investors continue to exit their gold longs, the proceeds are likely to remain overseas, supporting equities and sovereign bonds.

As USD/JPY enters phase 2 of its rally (alongside EUR/JPY), the Upper House Elections due in July will likely be the ideal catalyst for PM Abe to exercise a rare majority in both houses of the Diet and further grease the wheels currency-led reflationary policy. 108 in USD/JPY is our next key target, due in early Q3.