One of the key metrics we use for gold forecasting is again flashing a warning signal. We are referring here to the Japanese yen and its relationship with gold, as the correlation between these two asset classes has been incredibly strong for the last eight years and counting.
The best way to view the signal is to compare the two directly, one on top of the other. Below we show the Japanese yen (x 100) to US dollar cross-pair (top), with the price of gold immediately below (bottom), from 2011 through present:
The striking similarities between these two charts should be apparent from even a casual observation. However, let us dial the data points in more closely. Note specifically the following correlations between the Japanese yen and gold:
- Gold topped in September 2011 at $1,923 per ounce.
- Meanwhile, the Japanese yen topped two months later in November at 1.32 to the US dollar.
- The yen formed a secondary peak in September 2012 at $1.30.
- Gold formed its own secondary peak one week later at $1,800.
- Both declined simultaneously for nearly 3 years, from late-2012 through 2015.
- The Japanese yen bottomed first in June 2015 at 0.80 to the US dollar.
- Meanwhile, gold bottomed six months later in December at $1,045.
- In percentage terms from peaks to troughs, the yen had lost 40% of its value while gold lost a similar 45%.
- Both surged during 2016. Yen +25% and gold +32%.
- Following 2016’s surges, the yen peaked in June 2016 exactly at the 38.2% Fibonacci retracement of the entire 2011 – 2015 decline.
- Gold peaked just two weeks later at exactly the same 38.2% Fibonacci retracement.
- Gold broke higher from its long-term 2011 – 2017 downtrend (turquoise color) in July 2017.
- The yen broke higher from its related long-term downtrend six months later in January 2018.
- Both the yen and gold each broke lower from their primary 2015 – 2018 rising trends (royal blue) simultaneously in July 2018.
Fast Forward to the Present
It should be clear to see just how tightly correlated these two asset classes have been since 2011. Yet the key data point is what is occurring right now:
- The yen made a failed attempt to recover its broken primary trend in January 2019 (red callout).
- Gold is thus far just barely holding onto its own recovery attempt.
In other words, we must now ask ourselves the question: can gold now divorce itself from its relationship with the yen and continue higher, even though the yen has failed in its recovery?
Or, conversely: will the correlation between these two assets continue into 2019 – 2020? In that case, the yen is signaling that gold will continue to fall in price over the months ahead.
We can never speak in certainties regarding the markets, only probabilities. That said, we can make educated assessments based on observable data.
- During all critical turning points over the past eight years, the yen and gold have moved in the same direction within a period of six months variability.
- There have been zero major divergences in the direction between these two asset classes since 2011.
Thus, if the yen is going to continue lower and gold is going to break this correlation, it will be the first time that the two move in separate directions for nearly a decade.
While this is possible, we should place our bias with the observable data. We see no evidence that this relationship has severed yet. In the highest probability, gold should thus continue to decline over the months ahead until both find stability.
The Correlation Still Remains
We can prove that this correlation is still valid by plotting the above charts as a ratio. Below is the Japanese yen to gold ratio, from 1999 through the present:
Note that as this ratio falls, it means yen is losing value relative to gold. For example, we can see that yen lost 80% of its value compared to gold from 2000 through 2011.
However, an interesting thing has happened since 2011, shown by the blue callout: the ratio has nearly flatlined, with only minor variability.
In essence, what we are observing here is that there indeed has been zero net difference between yen and gold since 2011. The two are still “locked at the hip”. This has important ramifications for investors.
Why Does The Relationship Exist?
There is no single answer to this question, as the markets are the sum of millions of participants, each acting on their own beliefs, expectations, and knowledge systems.
However, likely reasons include:
- The overall low inflation rate in Japan, causing investors to perceive the yen as a safe-haven at certain times.
- The continued prevalence of the yen carry trade, in which investors borrow in the Japanese currency to invest in other markets. Thus exerting downward pressure on yen during periods in which “risk assets” are favored, in a manner similar to gold.
- A continuation effect by traders: participants become used to a correlation working for so long that it becomes a self-fulfilling prophecy – they buy gold when yen is strong and sell it when yen is weak, and vice versa.
Ultimately, we are more concerned with the fact that this relationship still exists, as opposed to identifying the myriad of reasons why it should be so.
Even more importantly, we want to know when the relationship finally severs. How will we know when this happens?
We will see it clearly on the second chart, as the yen to gold ratio will break in one direction or the other, finally.
From that point onward, we will no longer look for the correlation to hold, but for either gold or yen to reemerge as the premiere safety asset of last resort.
BULLION EXCHANGES MARKET ANALYST
Christopher Aaron has been trading in the commodity and financial markets since the early 2000’s. He began his career as an intelligence analyst for the Central Intelligence Agency.
Christopher Aaron specializes in the creation and interpretation of pattern-of-life mapping in Afghanistan and Iraq. His strategy has helped his clients to identify both long-term market cycles and short-term opportunities for profit.
This article is a third party analysis and does not necessarily match the views of Bullion Exchanges. Do not consider Bullion Exchanges as financial advice in any way.