The Currency Impact: No Gold Crash In Japan

 |  Includes: GDX, GLD, SLV
by: Disruptive Investor

Gold prices peaked out in dollar terms at $1,895 in September 2011. Over the next 19 months, gold has declined by nearly 26% in dollar terms. This is certainly a sharp correction and a largely expected one with gold being the best-performing asset class since the financial crisis of 2007. In this article, I will discuss the extent of the correction for gold in different currencies. The objective is to underscore the importance of currency strength or debasement on gold prices. Also, the measure gives the best- and worst-performing currencies in gold terms in the recent past.

The chart below gives the gold price correction in different currencies from September 2011 to April 2013.

Click to enlarge

In the last 19 months, gold has witnessed the sharpest correction in Chinese renminbi and U.S. dollar terms with a price correction of 28% and 26% respectively. On the other hand, gold has just corrected by 4.6% in Japanese yen terms and 4.2% in South African rand terms. Gold correction has also been relatively mild for in Indian rupee terms as the currency has underperformed in the recent past.

This chart underscores the high importance of currency debasement impacting gold prices. Gold has outperformed in yen terms largely because of the recent aggressive monetary policy stance by the central bank of Japan.

Click to enlarge

The dollar, on the other hand, has experienced strength on the back of a relatively resilient economy as compared to the eurozone and Japan. In the recent past, the dollar strength has also been due to a gradual commencement of "risk off" trade as indicated by declining yields. The 10-year Treasury bond yield has declined from a peak of 2.06% in March 2013, to below 1.7% currently. I have discussed in several of my earlier articles the reason for the dollar continuing to exhibit strength over the next 3-6 months. In line with this expectation, gold might not see any sharp rally after the recent decline. A consolidation at these levels might be the trend for the next 3-6 months for the precious metal.

The critical point to discuss here would be the long-term trend for the dollar. In general, a weak long-trend for the dollar would imply that gold prices might continue to trend higher. I am certainly not suggesting that the currency debasement is the only factor. However, this article discusses debasement as one of the important factors.

The chart below gives the real value of the dollar from 1998. Clearly, the dollar is on a downturn and I expect this trend to continue over the next decade.

Click to enlarge

There is no doubt in my mind that the U.S. economy is headed for sluggish growth over the next decade. In line with this expectation, I do believe that policymakers will continue with expansionary monetary policies resulting in a weaker currency against hard assets. I am not mentioning other currencies as there seems to be a race towards competitive devaluation. Countries however will continue to deny any currency war. The CBO has projected nearly $10 trillion deficits over the next 10 years. If this is true, government debt will continue to pile and the dollar will continue to trend lower. All other factors being equal, gold will trend higher on a weaker dollar.

I would therefore come to the same conclusion as in several of my earlier articles - The bull market for gold is far from over and the current decline is a great buying opportunity.

I must mention here that I am not just biased about the dollar. Central banks around the world are pursuing expansionary monetary policies and paper currency will tend to weaken against hard assets over the long term.

Physical gold and silver might be the best investment options for investors considering exposure to the precious metal pack. However, investors can also consider:

SPDR Gold Shares (NYSEARCA:GLD) ETF. The investment seeks to replicate the performance, net of expenses, of the price of gold bullion.

The Market Vectors Gold Miners ETF (NYSEARCA:GDX) is another good investment option for long term. The ETF seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the NYSE Arca Gold Miners Index.

iShares Silver Trust ETF (NYSEARCA:SLV) - The Trust holds silver bullion and is designed to provide investors with a simple method to gain exposure to the price of silver. The ETF has a relatively low expense ratio of 0.5%.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Plan to consider exposure to physical gold and silver at current levels and on any further correction