Japan Sparks Global Risk-Aversion

by Peter A. Grant

March 15, a.m.
(from USAGOLD.com) --

Gold is under significant pressure as unfolding events in Japan -- centered on the Fukushima Daiichi nuclear plant -- sparked broad-based deleveraging associated with risk aversion. The French nuclear safety authority upgraded the situation in Japan to a level-6 on the International Nuclear and Radiological Event Scale. The highest level of 7 has been invoked just once during the Chernobyl disaster in 1986. The Nikkei plunged an additional 10.6% today, weighing on stocks across Asia and Europe. The US stock market opened sharply lower and the DJIA was off nearly 300 points early in the session.

Markets in general are reacting emotionally, uncertain about the broad economic impact of the Japanese disaster, pushing investors to the sidelines. One might think that gold would fare well in such a situation and I think that assumption will prove correct following the initial round of deleveraging. You may recall that gold sold-off dramatically in 2008 in a round of deleveraging prompted by the near-meltdown of the US and global banking system. However, the safe-haven appeal of gold ultimately carried the day, with the yellow metal rebounding and pushing on to new all-time highs.

In a deleveraging frenzy, investors will frequently liquidate even profitable positions to offset losses in other asset classes. In many instances this seems counter-intuitive. For example, oil has sold off sharply, despite the reasonable expectations that the nuclear power industry is going to spend may years recovering from the Fukushima disaster. Japan reportedly has spare oil-fired electric capacity that they will almost assuredly have to tap. Renewed US interest in nuclear power was probably dealt a crushing blow that will leave us increasingly dependent on carbon based fuels for years to come. That should be bullish for oil, natural gas and coal. It may not be now, but it will be.

Similarly, many investors are liquidating commodity funds amid worries that the economic recovery in Japan is likely dead, which may in turn have a negative impact on recoveries elsewhere in the world. Most commodity funds have both energy and precious metals components, so those markets retreat. In selling the fund though, the investor is frequently selling gold even though they realize that they want to own gold as a safe-haven in the environment of uncertainty. We tend to see strong physical buying interest during these deleveraging events. The resulting rebound in physicals tends to draw investors back into various paper representations of gold.

As Japan ultimately moves toward rebuilding, that effort is likely to be financed my massive liquidity provided by the BoJ. Essentially, the central bank will create the yen necessary to rebuild the country. The BoJ has injected an additional ¥8 trillion in liquidity into the economy today after Monday's record ¥15 trillion pump. The BoJ has also increased its asset purchases by ¥5 trillion and there has been talk of direct intervention. Since Japan is the second largest foreign holder of US debt, I'm sure the Fed will be discussing contingencies for an absence of Japanese demand in the Treasury market. Additionally, if Japan must sell some of its Treasury holdings to help cover the expenses of clean-up and rebuilding, there is a risk of driving US interest rates higher. This threat to the US recovery could prompt the Fed to extend its QE campaign beyond June, which would likely drive gold higher.

Peter Grant is USAGOLD's resident economist and a well-known analyst globally in the forex and precious metals markets.

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