The Gold, the Bad and the Ugly

by Aaron A Day on February 15, 2013


The Gold, the Bad and the Ugly by Eric St-Cyr

“A mask of gold hides all deformities.”
Thomas Dekker

More than one year ago, I published an first column on Marketwatch.com named Dead Yen Walking. In that column, I advocated what I believed to be the best investment opportunity for the next few years. I recommended to go long USDJPY (long $US vs. the Yen), long CADJPY (long $Canadian vs. the Yen) and long XAUJPY (long Gold vs. the Yen).

The foundation for my recommendations was simple; the Japanese economy is a basket case. Japan’s debt to GDP is rapidly approaching 230% (by far the worst in the world), their trade surplus is morphing into a trade deficit and their population is aging as well as shrinking. It is simply impossible for Japan to repay its debts. The only way forward is to continually print Yen until the country enters into hyperinflation and implodes. The most difficult part of the recommendation was the timing of it…when will it start? I can now say with strong conviction that it started with the recent election of Prime Minister Shinzo Abe‬ to the head of the country. His politics of growth, higher inflation and lower currency value are exactly what the doctor executioner ordered.

Since January 2012, the USDJPY (number of Yen to the $US) moved from 76 to 93, a return of 22% in 13 months. Technical analysts and market timers are now saying that the trade is overdone and that we are due for a major pullback. I understand why they feel this way; nothing can go up in a straight line eternally. The daily chart clearly indicates that we should expect a correction soon. Figure 1.

USDJPY chart, Feb 2013

I do not deny the fact that the trade should be taking a breather at this point. However, looking only at a daily chart for the last 13 months is missing the greater picture we get by looking at the historical data since 1985 (Fig 2):

Figure 2: We are just started

USDJPY since 1985

In 1985 the USDJPY was over 260. The recent rise in USDJPY is nothing in comparison to the drop over the last thirty years. The only reason we can see that may stop the Yen from returning to its previous value is a deterioration of the US economy so severe that it would challenge the collapse of the Japanese economy. We don’t forecast such a scenario. The debt situation in the USA is bad, and is getting worse. Also, the lack of leadership in Washington is worrisome. However, the USA is not Japan. The United States has: a growing population, an open mind toward immigration, the global reserve currency and remains the economic and military world leader. These are all aces up Uncle Sam’s sleeve that should help avoid a catastrophe. Therefore, this trade should continue to do well in the months and years to come.

Are there better trades out there?

Even if you believe in the coming collapse of the Japanese economy, you need to remember that a currency trade is made of a pair of currencies; in this case the $US and the Japanese Yen. If, like me, you strongly expect the Yen to collapse in the coming years, you should then focus your attention to the other component of the pair, the $US. Is the $US dollar the strongest asset to pair against the Yen going forward?

Today’s reality is that the four largest global developed markets (Europe, USA, Japan, UK) are all trying to stimulate their economy by reducing the value of their currencies. By doing this, those economic powers look at increasing their exports and creating inflation.

Is there better currency out there? Certainly, the Canadian Dollar or the Australian Dollar comes to mind. They represent much stronger economies and their printing press was stopped a long time ago. However, those two economies also present high volatility due to their dependence toward the commodity market. If the world enters into a recession, the price of commodities will drop, bringing the value of the $CAD and the $AUD with it.

What about Gold?

As a disclaimer, I should first say that I am not a gold bug. When looking at the intrinsic value of the asset, I would by far prefer to own a $1000 in oil instead of $1000 in gold. However, I believe that gold shouldn’t be seen as an asset but more as a currency. The reality is that gold, contrarily to silver and platinum, has little industrial value. Gold takes its value from history, where for countless years it was considered a currency. People own gold as insurance, as a hedge, not as a working asset.

If you own gold, consciously or not, you are bearish $US dollar. Owning gold is being long GOLD and short $US. Let me explain: When you bought your gold, either physical or through an ETF, you gave Dollars in exchange for it. Therefore, you bought Gold (XAU) and sold Dollar (USD). In currency terms, we call that trade being long XAUUSD.

Now ask yourself, which currency out there will be the worst in the coming years? The Euro? The Sterling? The USD? Or the Yen? All of those currencies are bad, but one is truly ugly. The trade to enter in the coming years is long XAUJPY (buy gold sell Yen). This trade removes the uncertainty of the $US and leaves us with the best currency pledged against the worst. This is the perfect formula for a home run.

If you already own gold there are still a ways to execute this trade. For more information on this trade, and other ways Clover Asset Management can help grow your wealth please contact us at forwardthinking@clover.ky .

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