A few days ago a Seeking Alpha article, "4 Scary Charts Warning Of The Next Financial Crisis" provided analysis of the Japanese debt situation. Its concluding recommendation:
If the crisis I foresee unfolds it could make 2008 look like a blip. If such an event occurs, investors should prepare to diversify across a range of assets, such as short-term US Treasuries (SHY), gold (GLD) and US dollars (UUP).
The difficulty I have with this recommendation is with GLD currently. This is because since the beginning of the year Japanese rates and gold, as shown by the GLD exchange traded fund, have been negatively correlated (except for the 7 day lag).
Specifically this is the Japanese Government Bond (JGB) 10 Year rate daily change compared to the daily change of GLD. Here is a graph of the levels:
One can see the sharp rise in Japanese 10 year rates in the beginning of April from about .45% to over .85%. If one does the bond math (using excel) this would mean approximately a 4% drop in value for a 10 year bond with a coupon of .6%.
Obviously, any players in the financial markets, especially those who use leverage, have just experienced a large set back in JGBs. What to think of this?
My hypothesis is that when financial firms have a loss in JGBs they then sell gold to either provide cash for margin on their bond positions, or sell gold to rebalance their portfolios.
How can a trader use this? Potentially by analyzing JGB rate changes to trade GLD during the US trading session. And a trader, or investor, should recognize the increase in risk, for GLD, when there are large moves in Japanese rates. If you are a risk manager incorporate this data, as long as the correlation is significant.
Over the last month and a half over 22% of GLD's movement, found by adjusted R^2 in statistical analysis, has been related to JGBs change, from the day before and seven days ago, as shown in the results below:
The above table shows that, over this time period, if 10 Year rates increased in Japan then the next trading day GLD was likely to fall. As shown by the -15.46 coefficient. So a .10 rise in rates meant it was statistically likely GLD would fall by approximate -$1.55 the next day (ignoring here what happened 7 days ago). My opinion of this is to focus on the estimated directional change rather than a "point" forecast.
One's intuition might suggest that GLD would rise during turmoil in the Japanese bond markets, but most financial institutions don't believe in "hard" money when they have margin to meet and allocation procedures to follow. Traders, investors and risk managers should keep this in mind. Watch the correlations to see if, and when, this might change; such as, if Japanese firms jump on the gold short "bandwagon" and then the whole process might begin to work in reverse.
Note: Days when JGBs were closed were also deleted from GLD daily data