Currency Market Volatility Keeps Gold Underpinned

by Peter A. Grant

March 17, a.m.
(from USAGOLD.com) --

The threat of a rapidly rising yen was probably the least of the many worries of the Japanese people...at least up until Wednesday. The yen by all accounts held up remarkably well in the immediate aftermath of the earthquakes, tsunami and ongoing nuclear disaster as investors moved out of equities and into cash. You may recall that the dollar gained early in the US financial crisis for the same reason; flight from stocks into the perceived safety of cash. However, everything changed yesterday. [chart]

Late in Wednesday's session speculation that Japanese investors would sell overseas assets and repatriate funds mounted, pushing the USD-JPY rate through the all-time low at 79.50 from 1995. That promoted a cascade of stop-loss orders and program sales, which essentially left USD-JPY "bid-less" and the rate plunged more than another three big-figures, establishing a new record low at 76.25. I'm not sure anyone could have expected that after pumping trillions of yen into the economy to prevent a liquidity crisis, the BoJ would be contemplating direct intervention to stem a rise in the yen.

Clearly Japan is going to have to expend massive amounts of capital to rebuild in the areas devastated by the earthquakes and tsunami, putting their fragile economid recovery in jeopardy. However, the dramatic rise in the yen further complicates matters, making Japanese manufactured products -- the driving force of their economy -- more expensive on global markets.

Losses in the greenback against the yen are keeping the dollar index within striking distance of the 15-month lows from Nov-10 at 75.61. Below that, the all-time low in the DX at 71.74 from 2008 is seen as vulnerable. Persistent dollar weakness, along with continued uncertainty about the global implications of the Japanese disaster, ongoing geopolitical turmoil in the Middle East and North Africa and the rising specter of inflation have all conspired to generate buying interest in gold.

US CPI for Feb came in hotter than expected at +0.5%. Core exceeded expectations as well at +0.2%. These data come on the heals of yesterday's much larger than expected rise in Feb PPI. Heightened price risks will put pressure on the Fed to remove extraordinary accommodations sooner rather than later. However, the Fed will simultaneously be reluctant to do so as events in Japan weigh on the global recovery and as events in the Middle East/North Africa keep energy prices elevated, which frequently leads to recession. Recent grim US housing data has also stoked market expectations of QE3, raising the odds that a period of stagflation is in the offing.

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

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