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[beta]

Recent posts by Denleo and others stressing the importance of the yen carry trade to the continuing bull scenario got me thinking about the “fundamentals” of what might cause a stampede into the yen. Apart from black swan events such as a currency-rout by speculators, a more systemic cause of a sustained rise in the yen (if it happens) might be explained by the growing trade and investment relations between Japan and China. Many dont realize that China is now Japan’s #1 trading partner, the latter having overtaken the U.S. as of mid-2007. China is the #1 destination for outbound Japanese direct investments (private equity) and Japan, in turn, ranks only behind Hong Kong and BVI as one of the top sources of foreign direct investments in China. Sino-Japanese relations have been historically complex so wont go into that here, but the point is that going forward, the trend continues to be one of increasing cross-border capital flows and strategic economic ties between the two North Asian neighbors (and the same dynamic, to a large extent, with South Korea, which is situated between both countries), esp. with regards to pricing of energy imports on which both countries depend. So, if this trend continues, how will it impact the yen, USD, gold? If I were the Chinese government (and having dealt with Sino-bureaucrats), my immediate solution to the falling USD crisis would be to hedge my USD holdings by increased buying of yen. This has several advantages for China: (1) continue to diversify away from USD currency risks, which presently account for 2/3 of China’s foreign currency holdings; (2) force global speculators to put the brakes on a liquidity binge which destroys the value of their USD holdings; (3) induce FDI from Japanese investors w/ attractive currency exchange, but still keep leverage (chokehold) over an important trading partner with whom there has been a lot of historical distrust. (Others have noted China’s support of a strong yen for competitive export-devaluation purposes, but I think that’s less important given they compete in different export market segments). Many goldbugs have speculated for a while that China would try to accomplish a lot of the same goals by buying gold to hedge USD assets, and I still believe that is their ultimate objective. The fact that China’s gold exchange debuted (in late 2002) around the same time that gold prices bottomed is no coincidence IMO. The opening of similar gold exchanges in Japan and Korea this October presents another significant development in this direction. Essentially, China can buy yen short-term, then recycle their yen through the local gold exchanges. (Several reasons why this is more advantageous than directly buying gold in the NY/London markets w/ recycled dollars but that’s a long discussion). So, how does this relate to the “repricing of risk” theme trotted out by Paulson last week? First, I believe that when Paulson speaks, people LISTEN (I certainly do). In fact, Treasury appears to lead the Fed, in this case. IMO Paulson’s comment about “repricing of risk” is telegraphing to the markets that long-term yields will invariably rise, and the US either cannot or will not intervene to stop it. At best, they can secure the cooperation of its two largest creditors – Japan and China – to let the angle of descent be gradual, instead of a freefall (in nobody’s interests, except the speculators). Again, China’s strategy of triangulating gold purchases through yen/won buying may relate to this “USD soft landing” goal. Bottom line: this is NOT late 90’s IMF crisis mode, where the tidal flow of capital from Asia resulted in giant pools of liquidity seeking “safe haven” in the USD. At the same time, rising yields should give some support to the USD. Also, China has no short-term interest in a US market collapse. A while ago, I predicted here that the current Bull Market in equities would top when top-tier underwriters like GS floated Chinese issues to the US public to create a retail mania – we’re almost there, aren’t we? (I give it 3-6 months). Certainly, no time to be a complacent bull.

[xe2dy]

I agree, it's hard to ignore the inverse relation. Maybe a H&S in QLD or a 'W' bottom in QID.


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Edited by xe2dy, 29 July 2007 - 01:27 AM.