Is it a good time to buy Gold? (as a Singapore Investor in 2024)

For those who have been following – the big story last week was the depreciation in the Yen.

The yen has depreciated sharply above the key 151 level, and has weakened to levels last hit in 1990 (more than 30 years ago!).

At the same time, gold price has started to break out.

After going as high as $2400 at one point, it then dropped back down to $2328.

But the monthly chart below shows the significance of this move.

Gold price has broken out above all time highs:

It some ways, the JPY depreciation, is linked to Gold’s surge, and is linked to how the Feds may react in 2024.

This has broader implications for how Asian currencies, and risk assets may play out in 2024.

So 2 big topics I wanted to discuss today:

1. JPY depreciation – what will the Bank of Japan do next?
2. Is Gold a good investment?

As always, I want to walk through step by step the thought process, as it is important to understand how everything fits together.

If you just want the conclusion, feel free to jump straight to the conclusion at the end.

This is an FH Premium article written in early May.

I wanted to release it to all readers so you have an insight into my macro views – as it has big implications for how 2024/2025 may play out.

If you find this useful – do sign up for FH Premium for more premium articles like this, including my latest up to date views on Gold. 

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Yen has dropped to 1990 levels

This is the monthly chart of the Yen for reference.

After breaking the key support at 151, the Yen rapidly dropped to 159, which is the weakest the Yen has been since 1990:

What is the BOJ’s Dilemma?

The impossible trinity states that each country can only control 2 of the following factors:

1. Free flow of capital
2. Fixed Exchange Rates
3. Independent Monetary Policy (interest rates)

Singapore’s MAS for example, has chosen (1) and (2), which means that we do not control interest rates (hence SGD interest rates follow US interest rates very closely).

Now the dilemma that the Bank of Japan (BOJ) faces, is that:

• BOJ wants free flow of capital – this is critical for their export business
• BOJ wants to keep interest rates low (with the amount of government debt they have, allowing interest rates to go up would cause government interest payments to explode)

The impossible trinity therefore suggests that the BOJ cannot control JPY FX.

They can do so for short periods of course, but not for an extended period of time.

On cue – the JPY has been depreciating since the Fed rate hike cycle

And on cue – the JPY has been depreciating ever since the start of this Fed rate hike cycle.

Back in March 2022, before the Feds starting hiking interest rates aggressively, the JPY was as strong as 116.

With the Fed hiking cycle, the JPY depreciated to as low as 151 in Oct 2022.

After Oct 2022, Powell and Yellen injected USD liquidity into the system (via Reverse Repo and TGA), providing some respite for the BOJ. The US banking crisis in March 2023 provided further respite.

But since then, the Yen has been weakening from as strong as 128 to 159.

Enter the JPY carry trade

The Yen carry trade works like this.

Borrow Yen at 0.5%.

Buy USD and park in T-Bills at 5.5%.

Earn the 5.0% spread.

What is the risk with the carry trade?

The risk is of course – FX.

If the Yen strengthens against the USD, the carry traders are screwed because they need more USD to repay their Yen loans.

If the Yen weakens against the USD however, the carry trades make out like bandits because they need less USD to repay their Yen loans.

Effectively they earn on the 5.0% spread, and they earn on the FX depreciation.

So a weakening Yen will supercharge the carry trade, a strengthening yen will reverse the carry trade.

The BOJ is boxed in?

To put it simply, the BOJ’s dilemma is as follows.

If the BOJ raises interest rates to stem the depreciation in the Yen:

Their funding costs will blow out.

After a decade plus of non-stop QE, the BOJ owns more than 50% of all Japanese government bonds.

If they raise interest rates to match the Feds, they will have to pay 13% of their GDP a year in interest.

Not only that but higher interest rates would slow the domestic economy, which is not what they want.

If the BOJ tries to defend the JPY

If they try to support the currency, well they will burn through theie USD reserves very quickly.

The George Soros vs Bank of England saga has taught us that when the currency is too strong, no central bank can prop it up against the private markets forever.

So if the BOJ tries to defend the JPY, they make end up burning through a good chunk of USD reserves without much to show for it eventually.

Don’t forget that as long as they defend the JPY, it makes the carry trade even more lucrative as speculators know that the BOJ are supporting the Yen.

This would increase the carry trades and outflow from the JPY, until such point the BOJ runs out of reserves.

The other consequence defending the currency, is that they will need to sell US Treasuries to prop up the currency, which will cause US yields to go up, which would make the US very unhappy in an election year.

Of course, the Fed can choose to give the BOJ a direct USD swap line for this purpose, but that would be a resumption of the money printing route. (and bullish risk assets). It is also a short term solution in that it does not solve the underlying issue.

What is the end game for the BOJ?

Long story short – there are only 2 sustainable outcomes for the BOJ.

Either:

1. Defend the JPY until the Feds cut interest rates (providing reprieve for the JPY by narrowing the spread in interest rates)
2. Let JPY depreciate

The problem with (1) is timing.

The BOJ can defend the JPY for short periods of time.

But the longer the US doesn’t cut, the more they burn through their reserves.

What will the BOJ do?

For the record, these were the comments from the BOJ last week:

“… There was no opposition from the board today on continuing to buy at the current pace of roughly 6 trillion yen per month.”

 “Currency rates is not a target of monetary policy to directly control. But currency volatility could be an important factor in impacting the economy and prices. If the impact on underlying inflation becomes too big to ignore, it may be a reason to adjust monetary policy.”

Basically, the BOJ are saying that they will continue QE, to keep interest rates low.

And on currency – they think volatility in the JPY is a problem, but the absolute rate of the JPY doesn’t matter as much unless it impacts domestic inflation.

With these remarks the market took it as a green light that the BOJ would not defend the Yen in a big way, which led to last week’s sharp devaluation.

Powell’s Dilemma

Enter the Feds.

Big picture wise for the global economy, we are witnessing something similar to the Asian Financial crisis dynamic:

1. The US economy is very resilient, and US inflation is high, which means US interest rates will stay high. This leads to a strong USD relative to all other currencies.
2. At the same time, the rest of the world ex US is not as strong and needs to cut interest rates soon. If they do so before the Feds, their currency will depreciate vs USD.
3. This makes US a very attractive carry trade – for eg. to borrow in Yen at low interest rates, buy US assets, and earn from the strengthening USD vs Yen.
4. This problem has been exacerbated by the fact that US inflation remains strong, which affects the ability of the Feds to cut. If the Feds don’t cut, other central banks cannot cut without risking currency depreciation

So Jerome Powell is now in a dilemma:

1. Don’t cut interest rates – keep USD strong and try to solve domestic inflation, but the rest of the world is not able to cut interest rates without currency depreciation (the BOJ dilemma will play out globally, forcing countries to choose between (a) economic slowdown due to higher rates or (b) currency depreciation)
2. Cut interest rates – but likely inflate an asset bubble in the US, and reigniting inflation (given that the US economy remains resilient and inflation has not been tamed)

Hence you can see how inflation has been a complete gamechanger this cycle.

Unlike previous cycles, you cannot just slash interest rates to zero without consequences anymore.

Every day the Feds don’t cut, central banks around the world will be forced to make hard decisions.

What are the Feds likely to do?

This being a US election year, my money is still on (2), but some caution is definitely warranted in case Powell chooses (1).

For the record – if we see (1) the only real hedges are probably cash / Treasuries, as this is an economic slowdown scenario. Hence the importance of comfortable cash levels.

How to hedge a scenario like that (higher inflation)

If we see (2), I think the key assets that would benefit are:

1. Gold
2. Bitcoin (or crypto)
3. US Tech
4. Commodities
5. Banks/REITs (possibly)

We’ve talked quite a bit about 2 – 5 in the past.

So I want to spend some time talking about gold.

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What is the purpose of gold? For a Singapore Investor?

Gold is quite a misunderstood asset class.

It’s not a risk on asset like Bitcoin/US Tech.

It doesn’t really have industrial use like commodities so it’s not as exposed to the business cycle.

It’s basically an alternative to cash that does not pay interest.

The fact that gold does not pay an interest, means that gold only does well in cases where:

1. Real interest rates (inflation adjusted) are low, and
2. When you would expect currency volatility.

What has been driving the recent demand in gold?

Based on what we are seeing so far, much of the move in gold is driven by strong demand in the physical market.

The people buying gold are not looking for paper exposure – they want to take physical delivery.

This suggests the buyers are looking for some hedge against geopolitical / currency / government risk.

A few key groups come to mind.

First of course is central banks.

If you’re the PBOC (China central bank), after what happened to Russia’s US reserves you’re not going to hold much USD reserves going forward anymore.

Gold is a natural alternative, and we see even central banks like MAS buying more gold of late.

The other group is retail investors hedging currency depreciation.

For example if you are a Japanese investor, and domestic interest rates are 0.5%, and the JPY keeps depreciating.

Holding some gold may make sense, because the 0.5% interest rate opportunity cost is not a big deal, while gold hedges any JPY depreciation.

Likewise for Chinese investors concerned about a RMB depreciation.

And finally once gold starts to move, the speculators pile in, and drives the move further.

Gold price breaking out

Within that broader context, the recent break out in gold starts to make sense.

Gold price has broken out above $2050 in Feb 2024.

It then quickly went as high as $2400 in the span of 2 months, before retracing to $2330.

Here’s the long term monthly chart of gold for reference.

Based on a breakout chart like that, I think there is a good chance gold would continue to go higher in the mid term, especially when you consider the macro background discussed above.

My personal view on gold?

The way I see it, the inevitable mid term path is for more money printing.

Whoever wins – Trump or Biden, is not going to reduce the fiscal deficit one bit.

And at some point, the interest expense on all that US government debt will be so crippling that the Feds will cut rates and monetise the debt (buy government bonds).

The only question is what happens in the short term, before we get there.

The short term, ultimately depends on how Powell / Yellen react in a US election year, and is a tough one to call.

But mid term, I see key beneficiaries of the money printing as:

1. US Tech
2. Bitcoin (or crypto)
3. Gold
4. Commodities
5. REITs (although a bit tricky as it depends on what kind of real estate and where interest rates go – I would stick to Singapore real estate, and REITs with strong balance sheets)

Those with access to the personal portfolio know I run fairly meaningful allocation to gold, and I think gold could be an interesting diversifier from the usual Bitcoin/US Tech, and as an alternative to cash.

Like with all things in investing, you don’t want to all-in gold, but a decent allocation could provide meaningful diversification.

Closing Thoughts: Is all this in China’s interest?

Okay this final part is a bit speculative, so take this with a pinch of salt.

I was reading a strategy book over the weekend, and a key bit of wisdom was the thinking that you don’t want to create problems for your enemy (as problems can be solved).

You want to create dilemmas – such that whatever option your enemy picks, they are bad choices.

China is the second largest economy in the world, and a major exporter to almost every other country.

So you cannot separate China from the discussion above.

And what has China been doing of late?

China has committed to keeping the RMB relatively stable.

In fact look at how stable the RMB has been the past year, and compare that with what other currencies like the JPY are doing.

Is this intentional by China?

If China weakens the RMB, it helps bring US inflation down (cheaper imports for US, lower commodities prices), bringing inflation down and allowing rate cuts. It would solve the dilemma for the Feds.

By keeping the RMB strong, yes China is exacerbating the domestic pain in real estate.

But they are creating a big dilemma for both the US and Japan.

While also positioning the RMB as a stable alternative to USD / JPY for emerging markets.

And perhaps the thinking is that China’s political system will allow them to withstand the domestic pain much longer than other democratic nations.

I’ve always been wondering why China refuses to inject the necessary stimulus required for the real estate crisis to begin the necessary deleveraging process. Perhaps this is one reason why.

But like I said, this last part is pure speculation.

So do take it with a pinch of salt.

This is an FH Premium article written in early May.

I wanted to release it to all readers so you have an insight into my macro views – as it has big implications for how 2024/2025 may play out.

If you find this useful – do sign up for FH Premium for more premium articles like this, including my latest up to date views on Gold. 

I share my full stock / REIT watchlist, and personal portfolio (with weekly updates) on FH Premium.

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