What Could Derail Gold’s Bull Run? Watch Japan

Welcome toMoney Distilled. I’m John Stepek. Every week day I look at the biggest stories in markets and economics, and explain what it all means for your money.

Is this what lit the fire under gold?

I realise I’ve written about gold quite a bit recently (don’t worry, I’m sure another house price piece is coming any day now!), but it’s been unusually interesting, so I feel I must.

Gold hit another fresh record all-time high yesterday. It has been making a habit of this over the past week or so.

There are lots of sensible reasons for gold to rise – hefty public debt loads, particularly in the US; ongoing concerns about inflation; a sense that central banks are now keen to cut rates given any excuse; and background buying by central banks, are just a few of those.

But you could have pointed to most of those reasons at any point in the last few years, and they would have been relevant then too.

The question that’s been baffling analysts is: why now?

An interesting research note from Louis-Vincent Gave at Gavekal points in the direction of a persuasive smoking gun. A central bank is involved, but for once, it’s not the Federal Reserve. It’s the Bank of Japan.

As you’ll no doubt recall, Japan pioneered zero and even negative interest rates long before the rest of the world felt the need to dabble in it. Now, like everywhere else in the world, inflation is finally taking hold in the Japan, putting pressure on the central bank to abandon its ultra-loose monetary policies.

One side-effect of Japanese rates being so low for so long was that a lot of Japanese money went overseas to look for returns. As a result, a big worry going into this year was that Japan would raise interest rates rapidly, which would pull a lot of Japanese yen back home, causing convulsions in asset markets everywhere.

Instead, the Bank of Japan — understandably reluctant to move too fast to “normalize” rates after trying to fan the flames of inflation in vain for decades — has moved so delicately, that the yen is still hovering near 34-year lows against the US dollar.

A Yen for Precious Metals

That might come as a bit of a relief to any who were concerned that a big move by the Bank of Japan might rattle the tectonic plates of finance. But it appears that Japanese savers themselves are getting fed up with what a “hard” money advocate might describe as “rampant currency debasement.”

As Gave points out, “trading volumes in the Japan Physical Gold exchange-traded fund started to go bananas” right after last month’s Bank of Japan meeting, at which the key interest rate moved all the way from negative 0.1% to positive 0.1%

Meanwhile, the Chinese authorities aren’t just going to sit there while Japan lets the yen tread water near record lows. China needs to stay competitive with Japan and as a result, says Gave, the Chinese authorities allowed the yuan to fall below the 7.2 mark to the dollar, which they had previously been defending.

In other words, you have citizens of the two biggest Asian economies watching as their savings are devalued by their governments engaging in what you might describe as an understated currency war.

Given these devaluation risks, and the lack of appeal of other assets from bonds to property, “gold’s rally makes a lot of sense if you’re sitting in Asia,” as Paul Dobson, Bloomberg’s Asia Markets Executive Editor, put it earlier this week.

What Could Burst Gold’s Balloon?

This is quite pertinent to today, because later on we have a pretty big economic data point in the US. It’s the latest inflation reading from the consumer price index (CPI). If it’s higher than expected, that would suggest the Federal Reserve can’t cut rates. If it’s lower, that would give the Fed more excuse to be dovish.

In “normal” times, you’d expect either of those outcomes to have an impact on the gold price, especially after a big run-up like this one. And maybe it will — nothing goes up in a straight line after all.

(That said, it’s hard to say exactly what effect which outcome would have. A “hot” print would suggest higher-for-longer interest rates, which would typically be deemed bad for gold. But it might also be taken to imply that the Fed lacks the stomach to do what it takes to tackle inflation, which would be bullish for gold. You can tie yourself in knots with this stuff).

Anyway — the wider point is that maybe it’s not the US economy or even the Federal Reserve that matters most right now for gold.

Instead, argues Gave, gold bulls should be warily watching the Bank of Japan for signs of it turning hawkish, thus strengthening the yen. “For now this doesn’t seem to be in the cards. But this is probably the greatest risk to the unfolding bull market in precious metals,” he wrote.

Other risks include a crackdown by China on its citizens buying gold, or the potential for the burgeoning Chinese equity market rebound to attract savers back into local stocks, neither of which he sees as hugely likely.

In short, says Gave, “the bull market in gold is being driven by events in the East, not the West. And if it ends, it will likely be because of events in the East.”

It’s the most compelling thesis I’ve heard so far for the recent surge. But I’m always open to alternative theories, so do send your thoughts in to the usual address: [email protected]. Note too that the longer this goes on for, the more likely the baton is to be picked up by other investors playing catch-up (we’re already seeing that in silver, for example).

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What I’ve been reading this morning

• Don’t miss Marcus Ashworth’s new column on the UK government’s ongoing attack on second-home owners — agree or not, it’s a good read and yet another example of politicians failing to think through (or not caring enough to do so) the second-order consequences of intervening in markets.

• For more on what’s partly behind this drive, see Matthew Brooker’s column on the budget problems battering the UK’s local councils — and why it means his neighbours’ gardens could be about to get a lot messier.

• Forget about daydreams of a four-day working week — it’s not going to be the norm any time soon, says Allison Schrager.

Mid-day markets

Looking at wider markets — the FTSE 100 is up 0.6% at around 7,980. The FTSE 250 is up 0.9% at 19,940. Gold is down around 0.3% at $2,340 an ounce, and oil (as measured by Brent crude) is up about 0.6% to $89.90 a barrel. Bitcoin is down around 0.1% at $69,060 per coin, while Ethereum is up 0.3% at $3,520. The pound is up 0.2% against the US dollar at $1.27, and is down 0.1% against the euro at €1.169.

Follow UK Markets Today for up-to-the-minute news and analysis that move markets.

Quote of the day

“The fact that there are 11 national grocers all competing for share means that someone is always coming strong and there are ebbs and flows in the market. I think the key for us is consistency.”

Ken Murphy
CEO, Tesco

The Tesco boss was keen to emphasise the competitive nature of the UK’s grocery market as the supermarket giant announced a solid set of full-year results this morning

Putting a number on… words of wisdom

28,000
The approximate number of words in JPMorgan Chase & Co. CEO Jamie Dimon’s latest annual letter to shareholders. Beth Kowitt looks at the benefits and risks of such missives, inspired by the GOAT, Warren Buffett

Before you go…

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The main stories to watch out for on Thursday include:

• In economic news, the European Central Bank is expected to hold interest rates. We also get an update on the UK housing market from the Royal Institution for Chartered Surveyors (RICS), plus the latest US weekly jobless claims data.

• In corporate news, a trading update is due from shower and flooring company Norcros.

Don’t miss theIn The City podcast.Every week, Bloomberg’s Francine Lacqua and David Merritt go behind the scenes in the Square Mile.