A YEN FOR GOLD / MACLEOD FINANCE

A yen for gold

The yen carry trade is blowing up, driving up global bond yields. Investors are slowly learning that the only safe havens are to be found in gold, silver, and storable commodities.

ALASDAIR MACLEOD

It started with Scott Bessent at the US Treasury intervening in the JPY rate doing a favour for Japan’s finance ministry in late-July.

As the chart above shows (scale inverted) the yen rallied sharply, did little for a month and this week suddenly rose again. 

Over the period of a month, the yen has rallied 5% against the dollar. 

Not only will Japan’s institutions be reviewing foreign bond and equity investments, but the carry-traders buying US treasury bills could become forced sellers to cover their yen shorts.

This matters, because the only way in which T-bill demand can be maintained is for the Fed to raise its fund rate to maintain an interest rate differential across global markets. 

Effectively, the competition to attract global investment funds is on. 

But we are getting ahead of ourselves, with respect to the consequences for the gold price which is our central theme.

Gold and silver steadied this week, following the expiry of September futures contracts to end little changed in early trade this morning. 

The sharp declines over that event reflected the unwinding of some minor speculative longs which had accumulated during August, particularly noticeable in the silver contract where open interest on Comex declined by 17,532 contracts from the mid-month peak:  

Open interest is now at its lowest levels for over 20 years, even as the silver price has rallied as the chart demonstrates. 

This tells us that the conditions for a bear squeeze on the establishment shorts have returned, because the only way for open interest is up.

Admittedly, part of the decline in silver’s open interest was due to deliveries totalling 5,274 contracts representing a massive 820 tonnes giving a total this year so far of 8,403 tonnes. 

Gold deliveries were remarkably similar at 5,227 contracts since mid-August representing 16.26 tonnes, giving a total for this year of 559.76 tonnes.

Comex is truly the largest gold and silver mine on the planet. 

Demand drives these deliveries, but it is not reflected in investor interest which on the basis of open interest in both contracts remains exceptionally low. 

Investors are still dithering as to whether increasing prospects for a rise in interest rates will be bad for monetary metals, because conventional wisdom says that it is so.

There is evidence that this is changing, because the oil price has risen sharply over the last month, forcing analysts to increase their inflation forecasts:

Only a few months ago, gold and silver fell when gold rose, so this is a notable change. 

Oil prices rising indicated higher inflation down the line and therefore higher interest rates. 

This was said to disadvantage gold because you would earn more by holding dollars. 

This argument assumes that the dollar represents safety and gold risk. 

That oil is now rising at the same time as gold tells us that markets are having second thoughts and that gold is safety and the dollar risk.

We saw this happen in 1973—74 when OPEC raised its reference prices in two steps, leading gold to first decline and then double over only three months, the classic double-take:

Today, the oil price is rising because US strategic reserves have effectively run dry, so the price suppression which was the object of the exercise has ended. 

As a major oil importer from the Middle East ,Japan will be very badly hit with inflation certain to rise sharply along with interest rates.

We appear to be undergoing a similar revelation to that of the ‘seventies. 

The collapse of the carry trade, admittedly in its early stages and therefore far from certain, is an added factor destabilising government and other finances, even leading to competition between borrowers for international funds.

If the 1973—74 experience is our guide, then based on risk reassessment gold should swing sharply higher as investors do their double take and the establishment shorts rush to protect their positions.