After the flash crash in gold: Andy Xie

The recent gyrations in precious metals seem to stem from correlated deployment of vast liquidity resulting from quantitative easing around the world. Some of these correlations are just due to people "stir-frying" the same stuff, not economic reasons.

By Andy Xie
April 22, 2013
Market Watch

BEIJING (Caixin Online) — The recent gyrations in precious metals, commodities, and both the dollar and yen stem from correlated deployment of vast liquidity resulting from quantitative easing around the world.

Some of the correlations are just due to the same people stir-frying the same stuff, not economic reasons.

As the quantitative easing around the world continues, such flash crashes will recur. It is possible that mass panics, resulting from such flash crashes, could change the trajectory of some economies.

The most important case is that, if the Japanese government bonds and/or yen holders panic over the Bank of Japan’s (BOJ) QE policy, the resulting chaos could trigger a financial crisis in Japan, and the resulting yen crash would push East Asia and the world into a crisis.

Gold has bottomed. The recent price gyration is manufactured to benefit big speculators at the expense of gold buyers in emerging economies.

Physical gold demand is from emerging economies, but the financial market resides in New York and London; it is a heavily manipulated market. Retail investors must be on guard for manufactured panic-euphoria cycles to fleece them.

The yen-gold correlation

Abenomics has triggered a massive reorientation of speculative capital in the world. Shorting the yen against multiple currencies has become a consensus trade. The Australian dollar and euro have risen due to this trade.

The BOJ recently released massive QE, almost doubling the quantity and increasing risks in asset purchases. It has reinforced the shorting-yen consensus, furthering liquidity flowing into this trade from other trades.

In addition to lifting some currencies without supporting fundamentals, the liquidity reorientation sucked some away from gold. One justification for the decline in gold price is the rising dollar. Its historical correlation with gold is negative.

Wall Street has been pushing the negative gold story for some time. I bet that the people who have been talking down gold will turn positive soon. It’s a game to fleece credulous retail investors who follow the trend but are always several steps too late.

Base and precious metals

China’s weak first-quarter gross domestic product number spooked the market, triggering a wave of selling. The market was talking about a Chinese investment boom.

Such a notion is laughable in China but was consensus on Wall Street. This is another example how inefficient financial markets are. People just believe what they want to.

The news was obviously bad for industrial commodities. Hence, the resulting selling is justified. But, the news was good for precious metals. Weaker growth may incentivize central banks to prolong QE, which supports gold. It decreases demand for stocks, which is good for gold too. Nevertheless, gold came down with other base metals.

Prolonged QE around the world has created vast pools of speculative liquidity. Some of the pools, like commodity specializing funds, have money in all commodities. When they lose money, they shrink positions in all commodities.

As a lot of high-profile speculators have been talking down gold, after they liquidated, and the gold market was fragile to begin with. The market gyration after China’s Q1 GDP data tricked people into panicking without asking questions.

Japan as a source of instability

I have written in this space that the yen USDJPY -0.01% was coming down. My case was based on Japan’s recession and sustained trade deficit. I still believe that yen is in a long-term bear market. The yen’s first 10% depreciation was due to these fundamental reasons.

The last 10% decline in the yen is due to the expectation that the BOJ would push it down. Hence, the market was coming for a free lunch, front-running the Japanese financial institutions.

The BOJ nearly doubled its quantitative easing and vastly increased its risk-taking. It intends to purchase long-dated government bonds, stock market exchange-traded funds and real estate trusts.

The market participants are incentivized to front-run the BOJ. This is why the Japanese stock market has skyrocketed to nearly 30 times earnings. Some of the boring Japanese consumer stocks are trading at nearly 40 times earnings.

The theory for the rise is that, as the BOJ pushes the yield on long-dated government bonds to zero, insurance companies and pensions must buy stocks. Even at 30 times earnings, they still get some return.

As bonds and stocks become so expensive, Japanese financial institutions may have to take the money overseas for higher yields in foreign markets. Hence, the yen value could go down substantially. This is the case for shorting the yen massively now. It promises profits from front-running the Japanese.

In the past two decades, there have been a few short periods of optimism over Japan’s stock and property markets, all driven by foreign money. Foreign punters were all betting on the Japanese people eventually sharing their view and buying from them at higher prices. None worked out. The Japanese have not been playing the game.

Is this time different? One difference is so-called Abenomics. Shinzo Abe, the new prime minister, must be flattered something has been named after him. Unfortunately, financial markets have a history of building up characters like him and, after taking profits, throwing them into the gutter.

The idea of copying the Fed is a ridiculous one. Japan has a low unemployment rate and the population is shrinking. What’s the case for pumping up demand? Where are the people who would produce and buy more?

Japan’s deflation was due to a combination of savings surplus and declining competitiveness. The yen’s value has been supported by the resulting savings or trade surplus, while wages have declined due to declining competitiveness.

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