Written by Nico Pantelis
The earthquake that struck Japan on Friday March 11 was the worst in decades. In addition to the massive loss of life, it will have devastating economic consequences. I estimate the direct cost of the earthquake and tsunami at more than 10 trillion yen, as many offices and factories were destroyed. The indirect cost is likely to be even greater and is estimated at 30 trillion yen. This will manifest itself through higher unemployment and shaken consumer confidence.
It was interesting to see that the US dollar did not profit from the flight to safety as a result of the earthquake. Instead, investors fled into the Swiss Franc, German government bonds and the Japanese yen. Japan’s currency rallied strongly as carry trades were unwound. Initially, the gold price retreated as assets such as gold and silver and other commodities were sold in order to meet margin requirements.
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However, in common with many other countries, we believe gold demand in Japan is likely to rise significantly in the next few years. But Japan does not have a gold tradition like China and India, and Japanese demand for silver is only about 2,000 tonnes, or nine per cent of the world total. The largest end user is the industrial sector – comprising activities such as solar cell manufacturing, automotive production, construction and medical uses. Jewellery and silverware is marginal with regard to end-user demand.
In the gold market, Japan’s share of global gold fabrication – not taking into account investment demand – is about six per cent of the world total, most of it going to the electronics industry. Figures compiled by GFMS show that apart from Q4 2008, Japanese investors have been net sellers of gold bars, though recently the premium on gold bars in Tokyo has risen substantially.
Why then do I expect Japanese gold demand to rise in the next few years? The answer is quantitative easing. In order to finance the re-building of the country, the Bank of Japan will put the pedal to the metal in cranking up the printing presses. It is also likely to tap into its discretionary budget for 2011 and earmark two to three trillion yen for reconstruction. This will further erode the value of the yen and boost Japanese demand for gold as a hedge against this currency debasement.
Japanese investors will likely soon realise that investing the bulk of their money in Japanese government bonds is not only a low-yielding strategy, but actually a dangerous one. Although Japan has been mired in deflation for more than 15 years, inflation may return sooner than most think. I believe gold offers the best protection against the erosion of the value of paper money.