Monday, 31 March 2014

Is Mrs Watanabe Buying Gold?

Ralph Shell, Excel Analyst

Implementation of the Japanese consumption tax, from 5% to 8%, is going to commence on April 1st, another phase of Abenomics.  Attempting to reverse two decades of deflation, PM Abe has aggressively expanded the government's deficit spending.  The goal is a 2% inflation rate.

Excel Markets May 2014 Forex Demo Trading ContestCritics of the new economic plan have rightly observed  tax revenues are less than 45% of expenditures.  The Japanese accumulated sovereign debt is over 230% of the GDP.  Perhaps economic growth will eventually bail them out, but they also need additional revenue.  Therefore the consumption tax is beginning, and there will be another increase to 10% in 2015.

Because of deflation, the consumer became accustomed to postponing purchases.  Now, with higher prices anticipated, retail trade reports show the consumer has been only modestly more active.  After all, how many appliances does an aging population need?

Fooling the Japanese consumer is not going to be easy.  Traditionally, the money has been managed by women, the mythical Mrs. Watanabe.  Allegedly, this canny manager of the family funds has been successful investing in multiple asset classes.  The shift in asset allocation to equities last year helped to raise household financial assets to a record ¥1.63 quadrillion.

Now it looks like the Japanese savers are investing some of their saving in gold prior to the tax increase.  According to the Financial Times:

"A landmark increase in Japan’s sales tax has led to a rush for small gold bars as retail investors pile into the precious metal to avoid next week’s rate rise. <>Tanaka Kikinzoku Jewelry, a precious metals specialist, reported that sales of gold ingots across seven of its shops are up more than 500 per cent this month, as customers rush to take advantage of the current 5 per cent rate of consumption tax before it rises to 8 per cent on 1 April...

At the company’s flagship store in Ginza on Thursday, people queued for up to three hours to buy 500g bars worth about Y2.3m ($22,500). March has been the busiest month in Tanaka’s 120-year history."

Mrs. Watanabe may have made her decision: it is better to own a gold bar, than a shiny new washing machine, or a new Toyota.  Holding government bonds yielding only .62% has little appeal, and the future value of the yen is suspect.

PM Abe's attempt to revive the moribund economy, targeting a 2% inflation rate as a goal, is already having unintended consequences.   For the year the CPI in Tokyo is up 1.3%.  The lower yen, however, has meant more expensive imported energy and food.  Exclude those costs from the CPI, and it is up only 0.4%.

There is another major problem with Abe's 2% inflation goal.  Currently, the yield on a ten-year sovereign note, as previously mentioned, is 0.62%.  If we figure the real value of money is .5 to 1% above the inflation rate, this would put the ten year yield close to 3.0%.  Currently there is close to $11T in outstanding debt.  This means the value of the existing bonds would crash.  Banks who are required to mark the market the value of their bond inventory would not survive.  Further, the government could not refinance the outstanding debt.

For the owners of yen denominated investments, Mrs. Watanabe's investment of gold make sense.  For those that continually buy the yen as a safe have, this makes no sense.  As John Mauldin has repeatedly said, "the Japanese economy is like a bug looking for a windshield."

The demand from the Japanese investors for gold may not be big enough to make a dent in the huge global market, but it does illustrate weakness in the Abe plan, and some things are beyond Abe's control. 

Demography of Japan is a major problem.  Between 2010 and 2012, the population dropped from 128,056 026 to 126, 981,371.  Ethnic Japanese comprise 98.5% of the population, as immigration is not possible.  In 50 years 40% of the population will be over 65 and the population will be under 100M.

Contrast this demography to the one in the UK.  Between 2010 and the end of 2012, the population increased from 63.022M to 63.896M.  For the year-end 2013, there was a net immigration into the UK of 212,000.  Not all of the immigrants of the poor seeking work.  There have been so many multimillionaires flocking to London from Russia some are starting to call in Londongrad.

The British economy is vibrant and growing much faster than their neighbors on the continent   We intent to take a more detailed review next week, but it is our opinion that the pound is more of a safe haven than the yen.  Longer-term, we think the pound is positioned to far out perform the yen.

Since the breakout of the pound versus the yen with the arrival of PM Abe in late 2012, the pound has rallied from 135 to 174.  So far in 2014, the GBPJPY has been consolidating in a sideways move. 

Much of this market action may be the result of liquidation of the massive short Japanese yen position.  Once the stale shorts in the yen are gone we think the pound will gain on the yen. 

It may take quite a while to get there, but the monthly chart tells me the upside objective is 200 or better. 

Manage your money, because this could be a wild one.
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