As the European Union struggles with rising unemployment they now have to face a future of increased competition from the Japanese as they actively devalue the Yen. The new government in Japan, under the Premiership of Shinzo Abe, has managed to devalue the Yen by around 20% so far. In the short term this devaluation should boost Japanese exports as their goods are available at a substantial discount. This action mirrors that of the United States as they continue with their programme of Quantitative Easing. The United Kingdom has also joined in this ‘race to the bottom’ and has managed to reduce the value the British Pound.
The European Central Bank (ECB), under the guidance of Mario Draghi, cut interest rates to a new record low in May and said it would act again if necessary. However, in this tit for tat, cut for cut environment, the ball appears to be back in ECBs court. A money printing strategy may not appeal to Jens Weidmann, President of the German Bundesbank, however, the German car makers may think otherwise given the cheaper competition from Japan. Devaluation would also appeal to the other members of the union as they would see such a move as a boost for their beleaguered economies.
Devaluation of the euro
Now let’s assume that the ECB decide to print enough euros to match the fall in the value of the Yen, devaluation in the order of 20%. It then follows that this move would have a knock-on effect on the value of all of the other currencies including the U.S. Dollar. As the euro falls the value of the dollar would rise in terms of the US$ Index.
The dollar index weights each currency as follows:
Euro (EUR) 57.6%
Yen (JPY) 13.6%
Pound (GBP) 11.9%
Dollar (CAD) 9.1%
Krona (SEK) 4.2%
Franc (CHF) 3.6%
So we can see that any movement in the euro will have a major effect on the dollar. If a devaluation of 20% was achieved, then, not putting too fine a point on it, we have a drop in the value of this basket of currencies of about 10%, or an increase in the value of the dollar of about 10%. The dollar current stands at 83.57 so it would rise to about 92 on the Dollar Index.
Effect on gold prices in dollar terms
So what does this mean for gold bugs? Gold has an inverse relationship with the dollar, so in dollar terms gold prices could drop by 10%, which would take today’s price of $1400/oz down to $1260/oz. We are aware of the myriad of factors that we are not taking into account in this exercise, but we believe that the currency war deserves to be given a high priority in any investment considerations.
Recognition of this possibility does not mean that the bull market in precious metals is over, but it may present us with an opportunity to generate a profit while we are waiting for the rally to resume.
If the ECB does decide to print their way out of trouble then a trader could look to position themselves on the ‘short’ side of gold in order to take advantage of the fall in gold prices. There are a number of ways to do this including but not limited to: shorting some of the weaker mining stocks, buying put options on the weaker mining stocks and/or the gold ETFs, buying Put spreads with the view to profiting as metals prices suffer from price decay.
I’m not suggesting for one minute that you sell your physical gold or silver, but you could consider deploying some of your ‘opportunity cash’ in the short term. This sort of trading could also act as an insurance policy for your precious metals portfolio, should gold fall further.
Other considerations are the summer doldrums, a lackluster period for the precious metals sector, so our expectation is for further weakness. There are also the NFP jobs numbers out on Friday and if they are anywhere near reasonable there will be more talk of tapering QE, which tends to put a cap on gold’s progress.
Like all gold bugs we await the resumption of the bull market, but this phase of trending down has to come to a halt before we can take a bullish stance and hit the acquisition trail.
As bulls we can wait and hope for this period of consolidation to come to an end or we can recognize it for what it is; an opportunity to trade on the ‘short’ side. As retail investors we are small enough and therefore nimble enough to adapt our trading strategy to suit the changing risk/reward environment and make it work for us.
This strategy is helping us to generate cash and place us in a good position financially at a time when the gold and silver market is looking more than a tad gloomy.
It’s important that we do not close our minds to alternative strategies just because gold and silver prices have performed so well in the past. This is a correction, an opportunity, so use it to your advantage. Trading on the ‘short’ side does not mean that you are a bear on precious metals; it means that you have recognized a short term trend and as they say; the trend is your friend.
Now get out of bed earlier and do the work.
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