Watching the mood swings in the Nikkei puts me in mind of someone who would be considered manic-depressive. It has gone from Euphoria to acute Depression in the matter of 4 short weeks. The index has fallen over 20% from its best level this year which puts it in the category of official bear market territory. This is coming in spite of the Bank of Japan and the Abe administration's best efforts to kick the economy out of its state of deflation and induce a 2% annual rate of inflation.
What appears to be happening is that investors are losing confidence in the ability of the Bank of Japan to cure what ails this economy. Initially, upon the election of the new government, optimism that Japan's long season of discontent was finally coming to an end. The Nikkei began a monstrous rally that coincided with the sharp drop in the value of the Yen. However, what has derailed this bull train was the Japanese government bond market. It has proved to be a rebellious, strong-willed and recalcitrant child. Why? Interest rates are going the wrong way! The yield on the all important 10 year is going up, not down! This was not supposed to happen with the BOJ mopping up such a large chunk of those bonds on a regular monthly basis.
As interest rates have risen in Japan, the Yen is now reversing course and as it moves higher, it is sending stocks lower. What then appears to be occurring is a vicious circle in which the Nikkei then drops, sending the Yen higher, which in turn drops Japanese stocks lower, which in turn sends the Yen higher, etc... I think you get the picture.
The reason for this is those pesky speculators which were effectively herded, lemming-like in doing precisely what the Bank of Japan wanted them to do, namely, buy Japanese stocks, pushing the Nikkei higher and generating a wealth effect and a spillover happy optimism among the Japanese consumer and Japanese business. So much so that all the major hedge funds and large buyers of stocks had lost sight of the very concept of RISK. Why worry about that when the mighty BOJ was there to limit any downside moves in equities. As a matter of fact, let's just leverage our bets even more and load the boat for even bigger gains has been the thinking.
When the government bond market rejected this feel-good view, as bond investors wanted no part of locking in pitifully low yields for the foreseeable future, money came OUT OF JAPANESE GOVERNMENT BONDS to be put to work chasing yield in Japanese stocks. That sent interest rates soaring higher which is not want the Bank of Japan wanted.
As a result of this, money flows are violently reversing both in the short Yen trade and in the Long Japanese stock trade. That in turn is setting global equity markets on edge, particularly with all the noise surrounding the new buzz word in the US, "TAPERING".
Since we now live in the age of the zombie and the vampire in pop culture, we can call this newest movie, "The Rise of the TAPER". Sort of scares the hell out you just thinking about this hideous beast doesn't it?
Regardless, I have created a chart of the Nikkei futures indicating some potential support levels, which if it is going to stop falling, it will do so at these levels or else.
The first level of the support is a biggie. It is the 50% Fibonacci retracement level of this year's entire rally. It currently comes in near the 12192 level. Of all the Fibonacci retracement levels, this one is regarded as the most important. Generally, if prices are going to turn around, they will do so at this level. If they do not ( watch for an ancillary shock to US markets if they do not), they the index could drop down towards the red rectangle shown. That comes in between 11600 and 11200. If the Nikkei were to drop this low, I would expect the Yen to soar even more sharply putting even further pressure on the Yen carry trade. That would have big consequences for the entire financial market system, as heavily leveraged bets would continue to suffer huge paper losses.
MY guess is that there are currently a lot of phone calls taking place between the Fed and the Bank of Japan, along with the ECB.
How all of this would impact gold is a bit unclear right now. Back in 2008 when we had the massive unwind of the Yen carry trade, gold was clocked along with everything else as you recall. That was before all this Quantitative Easing began in earnest. Only the advent of QE reversed the bleeding as it encouraged speculators to come back in and speculate again, on the long side of everything in sight!
This time around we have had all the various QE efforts which have apparently run their course. Even some of the most die hard of stock bulls are beginning to wonder if stocks had gotten way ahead of themselves. I have said from the get go that the entirety of the stock market rally is nothing but a massive Central Bank induced bubble. I stand by that view. The bond buying has allowed the economy to muddle along with some improvement but as to generating any sort of robust growth, it is and has been an abysmal failure.
If investors begin to lose faith in the Central Banks and remember this is all a confidence game, then we might see gold actually function as a safe haven this time around. instead of a large flight into government bonds, which are becoming suspect to many, gold could withstand any unwind of the carry trade this time around, unlike it did in 2008. Again, I am unsure of this but one way or the other, we are witnessing economic and monetary history.
"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat
Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput
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