Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

Inflation on the Horizon; Beginning in Japan

The print-fest now six months old in Japan lost a little more credibility this week when the Nikkei 225 shed another 6.1%. That index is now 15.7% off its May high in less than a week’s time. Industrial output and, by extension, exports in the country have yet to gain any traction that would justify the Bank of Japan’s radical $1.4 trillion experiment. This could be due to the fact that most countries that Japan exports to aren’t able to consume as much as they used to (US consumer spending in April went negative [-0.2%] for the first time in 11 months), or it could be that asset (stock) inflation is growing apace with cost-of-living (energy and food) inflation – producing an earth-shattering zero-sum gain for the Japanese economy. That said, we have our doubts that the BoJ has any intention of ceasing or desisting anytime soon in regard to QE. Its CPI statistics, having persistently shown a decline in inflation for several months now, will likely serve as fodder for its now-imaginary fight against “deflation.”

5-31-13 Box ScoresWe make mention of the Japanese predicament because the BoJ’s record-setting action has done much to disrupt other nations’ markets. While the BoJ has printed, yen investment has strongly supported Italian, Spanish, and Greek debt; European stocks; the US dollar; and perhaps even US equities to some extent – just to name a few. This is not to say that US money printing hasn’t done the same. But Japan’s yen printing goes far to support the dollar, either directly or indirectly, whereas US dollars when printed tend to support US markets or higher yielding investments abroad. Said a different way, a printed yen has made the dollar look better and gold worse, per se, than they actually are. The situation is similar in many respects, but not identical, to the manner in which five central banks intervened in the markets in ’76, which aided and abetted gold’s famed retreat from $198 to $102 (before advancing to $400 in the next few years).

With the BoJ’s plans now unraveling, the dollar may actually begin to trade more freely and reflect the abuse the Fed has inflicted upon it in a more profound manner. Below is a chart of the dollar, rolling over this week as yen carry trades unwind, yet bouncing off its 50-day moving average on Friday. This action restricted gold’s gains for the week, yet validated the $1350 level (for a second time) as legitimate support.

Screen Shot 2013-05-31 at 4.47.13 PM

Next week, we should get a better idea of whether this week’s dollar-bear/gold-bull relationship will extend itself – as we suspect it will. With the BoJ having to question the wisdom of its policies, and the US economy sputtering (lower personal incomes in April, and a downward revision to 1st quarter GDP) enough to keep the Fed from ‘tapering off” its QE, the dollar should extend recent declines. Until the dollar market retreats in earnest, the precious metals will more than likely experience additional volatility. With the fundamentals shifting in the direction of higher uncertainty, however, that volatility should begin to favor the upside.

Best regards,

David Burgess
VP Investment Management