In Part 1 of this series last week, you read about the relationship between the Japanese yen and gold. We saw that both yen and gold are highly correlated.  Two thousand eleven marked the start of this. We move closely in tandem during both corrections and surges– since their respective peaks nearly six years ago.

As precious metals investors, what are we to make of this correlation? And how can we use the correlation to our advantage in the future?

Why Does the Japanese Yen and Gold Correlation Exist?

First, let us address the “why” behind the yen/gold correlation.

The bottom line is that no one truly knows why the correlation exists. Why? Associations between diverse asset classes never exist for solely one reason. Anyone who claims to have “the” answer only has one of the said answers. This is because markets make up millions of individuals. Each acts on its particular causes and assumptions.

Contributing Causes

That said, we can look to identify some contributing causes. Much of the correlation has to do with the perceived safety status of the Japanese yen. Although still a fiat currency, the yen is now one of the safest currencies in the world. This is according to international trade experts. It is perhaps even more so than the US dollar.

Japan is notable for its low inflation relative to other developed world economies. Although the country has large public debt, much of that debt is held domestically by investors. Japan also has a significant trade surplus. It sells more to foreign trade partners than it imports. The yen carries trade is a popular funding mechanism of the past decade. It’s when investors borrow the Japanese yen to buy assets in foreign countries. It is a testament to the stability of the Japanese economy and its ultra-low interest rates that investors perceive.

All of these reasons contribute to the safe-haven status of the yen. This, in turn, drives the correlation with gold.

Looking for Confirmation Signals

Although there is a myriad of reasons why the correlation is in place, for our purposes it will be valuable to accept that it does indeed exist. And to next look for ways to utilize this information.

One of the more valuable forms of analysis we can thereby perform is to monitor for either confirmation or non-confirmation signals. Signals that are between the yen to dollar cross-pair (JPY/USD) and gold. These can help us gauge significant turning points in the gold market.

For example, in June 2015 gold began to make new lows under the $1,200/oz mark. It eventually hit $1,045 in December of that year. However, note that the Japanese yen did not have a new similar low. So, instead, it was increasing marginally from 0.7950 to 0.8125 during this time:

Japanese Yen to US Dollar

Recall the main chart from last week’s article.

It shows the near-perfect correlation over six years between the pair. Here in 2015 was a non-confirmation signal for gold’s final plunge in 2015. The yen and gold were moving in opposite directions as a net sum. This over the last months of the decline.

What did this non-confirmation in the yen signal for gold? We will let the charts speak for themselves. We extend out the above by another seven months:

Japanese Yen to US Dollar

It is clear that the non-confirmation signal in the yen in late 2015 was an excellent predictor of what now shows as the final low for gold’s 2011 – 2015 bear market.

This is an essential signal for those who are interested in gauging likely turning points in the gold market. Of course, no sign will be perfect 100% of the time. But we can push the odds of probability into our favor for the gold market. That is if we pay attention to these confirmation or non-confirmation signals in the Japanese yen.

Watch for the Correlation to End

A final point on the topic for the time being. No correlation will last forever. There will come a time when the tight relationship between the yen and gold will sever.

What more, the period following the breaking of this relationship will be critical for precious metals investors to pay attention to. This is because it will signify either a rapid acceleration higher in the price of gold or a severe plunge. This will depend on the direction in which the correlation breaks. To illustrate, refer to the following set of embedded charts of the yen/gold ratio:

Japanese Yen and Gold ratio

We will know the association is ending when the yen/gold ratio breaks either above or below the converging set of (blue) trendlines. These define the relationship they have since 2011.

When you zoom in (bottom chart), it appears that there is much variability that can still occur in the confines of this relationship. However, when we refer back to the original (top) chart, we can see that in the grand scheme of these two asset classes, the correlation is still very tight indeed. A breaking point could come at any time within the next 12-24 months.

If the convergence breaks higher (less likely), it will signify that the yen is set to gain value relative to gold. Conversely, if the ratio breaks lower (more likely), it will hint that after six years gold is finally ready to resume leadership amongst the safe-haven assets again. Yet with a price rise in all currencies including the yen.


Christopher Aaron,
Bullion Exchanges Market Analyst

Christopher Aaron has been trading in the commodity and financial markets since the early 2000s. He began his career as an intelligence analyst for the Central Intelligence Agency. The CIA is where he specialized in the creation and interpretation of pattern-of-life mapping in Afghanistan and Iraq.

Technical analysis shares many similarities with mapping. They both base on the observations of repeating and embedded patterns in human nature.

His strategy of blending behavioral and technical analysis has helped him and his clients. It helps to identify both long-term market cycles and short-term opportunities for profit.

This article is a third-party analysis. It does not necessarily match the views of Bullion Exchanges. Readers should not consider it as financial advice in any way.

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