Bank of Japan’s bazooka, gold and “nerd’s gold”

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  • Japan: The world is about to be flooded with yen.

    Japan: The world is about to be flooded with yen.

  • Nikkei 225 over the last year

    Nikkei 225 over the last year

  • Gold plunge over the last year.

    Gold plunge over the last year.

  • Bitcoin: virtual currency

    Bitcoin: virtual currency


The world continues to be flooded with cheap money as central banks engage in monetary easing. This grand financial experiment is likely leading to some aberrations and distortions in fiat currencies, precious metals and some unique alternatives. This is presenting investors with unique risks and opportunities.

Japan

After suffering two decades of deflation, falling asset prices, nominal stagnation and policy paralysis, the Bank of Japan (BOJ) took out its monetary bazooka and fired a salvo of historic proportions. Its new monetary policy of aggressive easing involves doubling the monetary base over the next two years, more than doubling holdings of Japanese government bonds, ETFs and other risk assets.

This, dear reader, is a LOT of money.

At the end of 2012 the monetary base was JPY 138 trillion. Under the new programme it will increase to JPY 200 trillion by the end of 2013 and nearly double to JPY 270 trillion (that is 57 percent of Japan’s GDP) by the end of 2014.

The purchase of Japanese government bonds will be increased markedly from 40-45 percent of annual issuance to 115 percent. This will effectively monetise the entire fiscal deficit over the next two years.

In addition, the BOJ’s plan is to extend the average maturity of its holdings which will result in primarily buying longer-dated government bonds up to the 40-year tenure and consequently keep yields low across the entire yield curve. Although the Federal Reserve (Fed) has been one of the most aggressive asset purchasers, the new BOJ programme will even trump the US central bank.

The BOJ’s balance sheet is expected to increase by 40 percent this year (growth will be about 35 percent in the US under the current expected pace) and by 32 percent in 2014 (when the Fed is expected to have stopped its asset purchases). The world is about to be flooded with yen.

Since the initial intentions were announced the yen itself has fallen by about 30 percent against the US dollar. Most of this actually took place prior to the official details. The main goal of this easing is to nudge Japan out of its deflationary spiral and elicit inflation of two percent within two years.

The consequence of this move has been very fortuitous for those well positioned. The Japanese market, as measured by the Nikkei 225 Index has soared 55 percent in yen (only 27 percent in US dollars) since November of 2012. The Wisdom Tree Japan Hedged Equity Fund (Ticker: DXJ) (mentioned here: http://www.royalgazette.com/article/20130114/COLUMN05/701149987) is up 28 percent so far this year.

I think this rally could have further to go. I have yet to meet a global equity manager that is overweight Japan.

Japan has been hated and neglected for so many years that it is often forgotten. This massive rally is just starting to attract some attention. This surge is likely to be met with some near-term pullback and/or consolidation, but longer term the Japanese stock market could run much higher. On a price to book basis the Nikkei 225 Index is some 68 percent cheaper than the S&P 500. The yen is also likely to continue its fall as the BOJ seem very committed at this stage. The flood of yen has ignited the world’s global carry-trade again, where by traders and investors borrow yen and buy almost any other asset as their loans depreciate in value while they earn higher rates on foreign holdings. I say almost every asset because there is one that doesn’t seem to be working.

Gold

Something weird is happening to gold. It has changed its attitude. According to gold bugs (fans of gold), gold SHOULD be soaring on this huge monetary expansion that is happening globally.

But it’s not.

It should rally on geopolitical and financial crisis’s like that seen in Cyprus recently. But it’s not. It would seem that all this cheap and essentially free money now flooding the world financial system is not finding its way into traditional hard assets and inflation hedges but rather other financial assets like stocks and bonds.

Global yields have been compressed even further and stock markets globally continue to push upward. Commodities and gold continue to deflate. Gold’s bull market may be over.

I think the sentiment has shifted on gold. Maybe people are looking at alternative ways to hedge their disgust with the world’s central bankers attempt to debase currencies. Maybe they are turning to “nerd’s gold” instead …

Bitcoin

I’ll let Wikipedia explain this one:

“Bitcoin is a decentralised digital currency based on an open-source, peer-to-peer internet protocol. It was introduced in 2009 by a pseudonymous developer (or developers) Satoshi Nakamoto. Since 2011 Bitcoin has been criticised as not being a functional currency due to its experimental nature, volatile markets, and allegedly limited use in trade.

“Bitcoins can be transferred through a computer or smartphone locally or internationally without an intermediate financial institution. Each bitcoin is subdivided into 100 million smaller units called satoshis, defined by eight decimal places.

“Bitcoin has no central organisation and is not managed by any government or central authority. Instead, it relies on an internet-based peer-to-peer network. The creation of new bitcoins is automated and given to servers or ‘bitcoin miners’ that confirm bitcoin transactions as they add them to a decentralised and archived transaction log approximately every ten minutes.”

The key phrases for those tech-savvy libertarians who mistrust governments and central banks is that “Bitcoin has no central organisation and is not managed by any government or central authority.”

Unlike other fiat currencies there is supposed to be a finite supply with a limit of some 21 million bitcoins set to be reached by 2014. The fanatics see it as the future of the internet commerce, where the word can unite in a common digital currency rather than yen, dollars or euros. It is interesting to note that the rise of bitcoin also coincided with the tipping point of the financial crisis in Cyprus, when it was announced individual savers faced a one-off levy in order for a Eurozone bailout to go ahead. This is a nerd’s version of digital gold.

Could all this easy money and traditional gold’s fading lustre made a new bubble that has burst?

CHART

I would be VERY careful about Bitcoin. I would suggest that anyone even remotely interested in this new form of “virtual currency” approach any such forte as pure speculation.

This is not a currency recognised by any national bank and has become a speculator’s dream where deals worth millions of dollars have been trading at a record clip. In recent weeks, the value of Bitcoins fluctuated wildly and at one point topped $200 per coin — up from about $20 in February, then plunged back down to around $100 on Thursday as the market was halted for 12 hours.

It looks like Bitcoin has now fallen another 35 percent or so to $78 today (Friday). Not exactly a characteristic for a form of global currency that many would desire. Bitcoins could also become the domain of money laundering and computer hackers so its security is in question.

The world’s central banks continue to flood the financial system with cheap currency. This is slowly feeding into asset prices, even some unconventional ones. We have never witnessed this level of monetary easing and history provides no guide for this unchartered course. It will be important to be nimble and flexible in ones’ investment stance into the future. Those who maintain obdurate and static views that lack fiscal flexibility and imagination will risk seeing their assets deflate in real value.

Disclaimer: This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Anchor Investment Management Ltd. to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. Readers should consult their financial advisers prior to any investment decision. Anchor Investment Management’s clients and some employees own the Wisdom Tree Japan Hedged Equity Fund (Ticker: DXJ).

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Published Apr 15, 2013 at 8:00 am (Updated Apr 14, 2013 at 4:52 pm)

Bank of Japan’s bazooka, gold and “nerd’s gold”

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