Japan's newly elected president, Shinzo Abe, has signaled his intention to do whatever he can to devalue the Japanese yen in order to provide a boost to the nation's ailing economy. This virtually assures a lower yen and this article looks at how traders and investors can profit from it.
Last weekend Japan's Liberal Democratic Party (LDP) led by Shinzo Abe won a clear majority in the country's general election. Shinzo Abe has said that his top priority is the Japanese economy which has been combating deflation for over two decades.
He has been quoted as saying that he is in favor of "unlimited" monetary easing by the Bank of Japan (BoJ). It is also expected that he will nominate a new governor to replace Masaaki Shirakawa, whose term as head of the BoJ ends in April.
In the coming weeks, it is thought that Shinzo Abe will bring considerable pressure to bear on the BoJ to print fresh yen and inject them into the economy. The objective being to dilute, and therefore devalue the yen and spur inflation. Shinzo Abe has also said that he wants the BoJ to increase its inflation target from 1% to 2%.
Bruce Kasman, chief economist at JPMorgan Chase & Co., described the LDP party's election win as "one of the most important monetary policy events for 2013." Last week, Kasman's colleague Masamichi Adachi in Tokyo said that the BoJ may adopt a "new style of open-ended asset purchases" as soon as this week.
Chart courtesy of stockcharts.com
Thanks to the unwinding of the yen carry trade, the Japanese currency began a long uptrend in 2007. In late 2011, however, that rise came to an end and following a significant bounce that lasted much of this year, the yen now looks to be in a long-term decline.
How to profit from the decline of the yen
With so many of the world's central banks engaged in deliberate currency devaluation, it is increasingly difficult to find a strong currency to short the yen against. In particular, the U.S. Federal Reserve's 12 September announcement of open-ended QE makes the US dollar a less than ideal candidate, since both currencies will be declining simultaneously.
Perhaps, a better option would be to short the yen against one of the commodity currencies such as the Canadian dollar or the Australian dollar. That's because the Chinese economy appears to have made a cyclical bottom, and renewed demand for base metals and other commodities should benefit both Canada and Australia.
According to some sources, the sale of commodities such as iron ore and coal makes up nearly 55% of Australia's annual revenues, and the country's biggest client is China. As Ambrose Evans-Pritchard pointed out in a recent article entitled "The world's commodity supercycle is far from dead," in 2011, China's share of total world demand for commodities was: "soya (27%) cotton (38%), aluminum (40%) iron ore (40%), coal (42%), zinc (42%), lead (43%), copper (43%), and lean-hogs (50%)."
As a result of deliberate policies aimed at cooling its property price boom, the Chinese economy has slowed. However, it is still growing at over 7% and as Paul Bloxham, Chief Economist at HSBC pointed out recently, "Real commodity prices at well above their late 20th century levels are expected to continue to support Australia's growth prospects."
Evans-Pritchard also notes that the Reserve Bank of Australia argues that the construction boom in China "will not peak in absolute terms for another five years as 20 million rural migrants pour into the cities each year. The pace will not slow much until the urbanization rate reaches 70% in 2030."
The bottom line
There can be little doubt that the Japanese yen is headed lower. The difficulty for traders and investors, however, is finding a way to capitalize on it. As mentioned in my 13 July article:
Longer-term investors should consider buying a selection of Japanese exporters that stand to benefit from a lower yen... These companies are likely to see greater demand for their products, thanks to the greater relative purchasing power of foreign buyers."
The problem, however, is that Japan's traditional export customers, i.e. the US and Europe, have also now adopted ultra-loose, open-ended monetary policies aimed at devaluing their currencies. As a result the best bet for capitalizing on a weakening yen looks to be shorting it against the Australian dollar, perhaps via a spread bet.