Silver Prices and the Return of the Yen Carry Trade

In the futures pits, silver traders are seeing prices move downward as a result of the expression of market structure.

Nevertheless, that market structure and its macroeconomic backdrop is now changing, as the currency wars heat up once again as the world moves into a new year.

Europe seems surprisingly quiet as the U.S. congress debates the fiscal deficit farce and the much publicized Fiscal Cliff looms large on the country’s time horizon.

For its part, Japan has elected a new Prime Minister who has thrown out the previous Japanese government budget with promises of more economic stimulus. In addition, he has been potentially fomenting Japan’s already precarious relationship with its giant neighbor China.

The Yen Carry Trade

As a result of historically low benchmark interest rates in Japan, the Japanese Yen carry trade has been one of the primary long term strategies used by fund managers to profit from the forex market in recent years.

Although largely financed by exceptionally low Japanese interest rates relative to those observed elsewhere in the developed world, this carry trade strategy becomes even more profitable if the exchange rate of the other currency relative to the Japanese Yen remains fairly stable and leveraged transactions are available.

The basic Yen carry trade consists of selling Japanese Yen or borrowing in Yen and then using the proceeds to buy another higher interest rate currency, such as the Australian or New Zealand Dollars in today’s forex market. The trader hopes to hold the position over the long term in order capture the favorable interest rate differential, and leverage serves to magnify any returns seen.

Nevertheless, prior to 2008 when the Lehman Brothers bankruptcy sparked off the world’s latest Financial Crisis, the U.S. Dollar could also have been a relatively attractive long currency choice since U.S. interest rates were higher than they are today.

Is the Carry Trade Returning?

Interestingly, the forex market may soon be seeing the return of the USD/JPY carry trade given the new Japanese Prime Minister’s policies that have already led to declines in Japanese bond prices to test support.

If this is the case, then the point is that the resurgence of the Yen carry trade could signal a return to risk adversity that in turn could well cause money to flow to commodities like silver as a safe haven.

Furthermore, this occurrence coincides with the Fed’s new Quantitative Easing QE program that begins in January, the United States reaching its increasingly oppressive debt ceiling yet again, and a cleansing of silver market structure as the chronic shorts on the Comex are seeing plenty of long position liquidation to lower open interest and place the silver market into a technically oversold state.

All in all, these factors could well be paving the way for a flow of capital into the silver market as year-end approaches and the New Year begins.

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