Strain on Japanese yen showing in the gold market

The price of gold in Japan is at an all-time high. Tanaka Kikinzoku, one of Japan’s largest gold retailers, said recently that prices were approaching ¥10,000 per gram for the first time ever.

Official charts currently have the price closer to the mid ¥9000’s. Either way, it really has nothing to do with gold itself. This is a story of how the yen is continuing its historic slide against the US dollar, while Japan’s central bank is backed into an increasingly tight corner amid unconventional monetary policy.

The above chart plots the price of gold in yen over the last 20 years. In this sense, the commodity has served its purchasing power protection mandate well, delivering close to 5.7X returns for Japanese investors. The next chart shows the gold price in dollars, where American investors have seen 4.8X return in the same timeframe.

This shows that the yen has fallen against the dollar in the last two decades. Yet the outperformance, considering the long timeframe, is not massive, especially when compared to other currencies.

It is when we assess the last two years, however, that the divergence becomes significant. The start of 2022 can be viewed as an inflection point for the world economy, when inflation began to roar. That quarter is when the US Federal Reserve first hiked interest rates, with central banks around the world fearing overheating economies and spiralling cost of living.

Since then, gold in terms of yen has appreciated 37%, whereas in dollar terms, the return has been only 7% – over five times worse.

Japan’s unconventional monetary policy

The US Federal Reserve sets the short-term interest rate, known as the federal funds rate. It governs how cheap money is to borrow, which has knock-on implications for the economy at large. This key rate has been hiked aggressively in the last eighteen months, with the goal of cooling the economy and reining inflation in.

We have seen this tight monetary approach from central banks around the globe. Yet there is one exception: Japan. The Bank of Japan has bucked the trend by instead pursuing loose monetary policy. It has utilised yield curve control to manage long-term yields, a method which describes the act of central banks buying or selling as many bonds as necessary in order to target a specific longer-term interest rate.

In many ways, it is similar to conventional quantitive easing. Both quantitive easing and yield curve control involve the purchasing of government debt (treasuries) to affect interest rates and pump money into the economy. The difference is that quantitative easing involves the purchasing of a specific amount of bonds on a regular basis in order to inject this credit into the system. For yield curve control, central banks purchase as many bonds as necessary in order to keep yields at a certain level.

The bottom line is that the Bank of Japan is pursuing loose monetary policy while the rest of the world has been tightening. And after years of deflation, the nation is starting to see inflating prices.

Statistics in June showed inflation rose 3.3% in Japan, compared with a 3% increase in the U.S. This is the first time in eight years that the Asian nation has produced a higher inflation figure than the US.

Nevertheless, it is important to note that while the scales have flipped in recent times, one must keep an eye on the big picture. Prices in both the US and Europe have risen close to 20% since the start of 2021. Japan’s contrasts favourably in this regard, with prices having risen just over 5% in the same time period.

One also needs to mention wage growth. Salaries in Japan have not jumped as much as in both the US and Europe. Since the start of 2021, Japan’s wages have risen by 4.5%, compared to 7.5% in Europe and 15% in the US.

This wage growth is key with regard to the Bank of Japan’s goals, which outlined in April that it was determined to hit its 2% inflation target “accompanied by wage increases”. Therefore, rising inflation with lagging wage growth turns the difficulty level up on that goal.

How has this affected the yen?

This loose and unconventional monetary policy, combined with inflation, is now pushing investors to hedge their purchasing power. This explains the rise in Japanese gold prices through retail demand.

At the end of the pandemic, Japanese households had accumulated four times as many assets compared to the country’s GDP – the highest such mark in the world. Close to half of that was parked in cash, not a surprise with the aforementioned years of deflation. Yet with inflation now picking up, it is also not shocking to see a rotation into inflation-protecting assets.

This is where the yen comes in. With interest rates higher globally following tightened monetary policy elsewhere, capital is leaving the yen for more attractive destinations. Coupled with inflation domestically, gold has also become attractive.

The scale of the yen’s slide against the dollar is historic. Japan’s currency has lost 28% of its value against the dollar since the start of 2022.

Going back to the start of 2021, the yen has shed 43% of its value against the dollar.

The Bank of Japan has repeatedly stated that it is determined to hit its 2% inflation target, ruling out a pivot off the current policy despite increasing pressure. With prices accelerating faster than wages, however, while rates elsewhere dwarf those on offer for the yen, the Japanese currency is creaking.

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