Financial Times Aug 4 2010
http://www.ft.com/intl/cms/s/0/81552e06-9fe2-11df-8cc5-00144feabdc0.html#axzz1WV4KM3Sy
There are not many financial assets that are priced higher today than before the Lehman shock in September 2008. Two that have done investors proud are the yen and gold bullion.
At first there seems little in common between the yellow metal, which has been a store of value through the ages, and the currency of a country with feeble economic growth and Godzilla-sized government debt. Yet both are perceived as havens of safety in a troubled world. Strangely, the yen may be the more deserving of that accolade.
.Historically gold was indeed a store of value – until it became just another financial market asset, subject to the swings of speculative sentiment and hot money flows. The last bull market peaked out 30 years ago. The bottom of the subsequent bear market was marked by the UK Treasury’s sale of its gold reserves in 2001.
Over the intervening two decades, gold delivered a capital loss of more than 80 per cent in real terms, a performance far worse than any comparable period of equity market returns. Rather than storing value, gold destroyed it in spectacular style.
The reason is simple. By 1980, gold had become a classic mania, having risen 20 times since the closing of the gold window in 1971. Investors may have thought they were acting prudently at a time when the world seemed to be racing towards monetary Armageddon. In fact they were driving by the rear-view mirror – ignoring the extraordinary cheapness of equities in favour of the asset that had done the best in the past decade.
This time, the rise in the gold price is more modest – so far – but the irrationality of investors is, if anything, greater. At least in the 1970s it was clear what investors were hedging against – inflation.
More recently, the gold price has risen through a period of low inflation. Half of the increase took place in the 2003-07 period when global growth was strong and credit concerns minimal. The other half took place in periods of recessions and financial stress. Gold has become an all-weather investment, rising in both boom and bust.
The inconvenient truth is that gold is not really an investment at all. Since it generates no return and thus has no fundamental value, the same arguments can be used to justify any price – $500 an ounce or $5,000. Gold buyers are simply trusting in the bigger fool theory – that someone else will take it off their hands at a higher price. They are speculating, not investing, and like all speculators what they are speculating on is the speculations of other speculators. Packaging it in an exchange-traded fund makes no difference.
The yen, unlike gold, is under-owned. Few non-Japanese investors own yen cash or bonds, and central bank holdings are similarly derisory. Recent reports of a small purchase of Japanese government bonds by the Chinese government were enough to power it to a new high.
Furthermore despite the rise in its nominal value, the yen is not particularly expensive in real terms – thanks to year after year of untreated deflation. According to the Bank of Japan’s index of the real effective yen rate, it is much closer to its lows than highs of the past 20 years. In fact if the yen were to reach the highs of 1995, when it touched 79 to the dollar, it would need to rise another 50 per cent in real terms.
Best of all, the yen is not a sterile asset like gold. It generates a return. Officially CPI deflation is 1.5 per cent, which means holders of yen get a tax-free gain of 1.5 per cent in purchasing power every year. However, according to the American scholar David Weinstein, the official numbers understate Japanese deflation by several percentage points.
If he’s right – and intuitively 1.5 per cent does seem too low – then Japanese cash is generating a very competitive return. Maybe that’s why Japanese households and companies have been stockpiling it, come rain or shine.
There is a wrinkle. The supply of gold is small and constrained, whereas the Bank of Japan can create as much yen as it likes. This is exactly what several foreign observers and, increasingly, Japanese politicians have been recommending.
However, Prime Minister Naoto Kan’s disastrous decision to fight the recent Upper House election on a tax-hiking programme has thrown the political scene into chaos. Japan’s politicians are in no position to pressure anyone.
Of course the BoJ could change policy by itself, but that would mean admitting that its fundamental philosophy was wrong, which is about as likely as a midwinter cherry blossom. The battle for supremacy between the yen and gold looks set to continue.
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