Gold Price Outlook: Different Approach Needed Than in 1970s

Recently, as the dollar's value has declined, gold prices have surged. From the perspective that the value of physical currency ultimately converges to the price of gold, gold becomes an important consideration for investment portfolios. If Japan's inflation continues to rise, long-term bond yields will also increase, leading to interest rate hikes that exceed market expectations, affecting exchange rates and opening up the possibility of a stronger Yen. Gold is a representative form of physical currency, and understanding its characteristics is crucial.

Before 1971, when the Nixon Shock occurred, gold was valued at $35 per ounce. This meant that only $35 was needed to buy one ounce of gold. However, currently, one ounce of gold is close to $4,500. This phenomenon can be interpreted as gold prices rising, but it can also be seen as a significant decline in the dollar's value. Since the intrinsic value and physical characteristics of gold in the 1970s and now are the same, what has changed is the value of currency. The primary reason for currency devaluation is an increase in money supply, such as quantitative easing.

When a crisis hits in a highly indebted situation, debtors may go bankrupt, potentially leading to a cascade of failures among lending banks. When such global financial market crises escalate, the U.S. tries to overcome them by issuing dollars. Each time dollars are issued in large quantities during a crisis, the dollar's value falls, and conversely, gold prices rise significantly. Therefore, a pattern of dollar depreciation and gold price appreciation tends to repeat whenever debt issues emerge.

When a crisis occurs, governments attempt to stabilize markets by injecting money. This quantitative easing devalues the paper currency, the dollar, and conversely increases the value of the physical currency, gold. Just as it once took $35 to buy an ounce of gold but now requires over $4,000, if more dollars are circulated in the future, a day may come when $5,000 or $6,000 will be needed. The U.S. debt problem and declining confidence in the dollar lead to a fall in paper currency value, which in turn results in an increase in the value of physical gold.

Situations like the 2008 financial crisis or the 2020 COVID-19 pandemic, where vast amounts of money were released to overcome debt problems, could recur. In such crisis scenarios, the value of gold will be significantly highlighted. Therefore, alongside stocks and bonds, gold should be considered an important component of a risk-hedging portfolio.

While terms like 'stock manipulation country' or 'interest rate manipulation country' are unfamiliar, 'currency manipulation country' is often heard. The U.S. sometimes designates certain countries as currency manipulators every six months. This implies that exchange rates can be somewhat controlled by foreign exchange authorities, and such manipulation potential makes short-term exchange rate forecasts very difficult. Therefore, short-term predictions for exchange rates, including the Yen, must be cautious due to numerous variables and political dynamics.

Exchange rates are significantly influenced by political dynamics. The Plaza Accord in September 1985, where the U.S. forced Japan to appreciate the Yen, resulted in the Yen-dollar exchange rate plummeting from 250 Yen per dollar to 120 Yen within a year. Also, in 1995, as the strong Yen and the Great East Japan Earthquake caused difficulties for the Japanese economy, the U.S. tolerated a weaker Yen, leading to its depreciation. After the 2011 Great East Japan Earthquake, when the strong Yen again caused economic hardship for Japan, G7 approval for a weaker Yen led to Abenomics. Thus, exchange rates are influenced not only by economic logic but also by coordination between nations.

Since the latter half of last year, the U.S. has consistently demanded that Japan raise interest rates. If Japan does not raise rates, there is no way to curb domestic price increases, and this, in turn, causes Japan's long-term bond yields to rise, which then pulls up U.S. interest rates. Therefore, the U.S. is urging Japan to raise interest rates by pointing out its inflation problem. It is expected that Japan will raise interest rates this month if there are no major issues, and if interest rate hikes exceed market expectations not just once or twice but several times, this could affect exchange rates and increase the possibility of a stronger Yen.

Abenomics, which began in 2012, was an economic policy pursued by Japan after receiving approval for a weaker Yen. Past cases show that exchange rates are influenced not only by economic factors but also by coordination among specific countries or political誘導 (guidance). The U.S. has continuously demanded Japan raise interest rates since the latter half of last year. This is to curb Japan's inflation and prevent the rise in Japan's long-term bond yields from pulling up U.S. interest rates, as it would be difficult to curb inflation within Japan if the Bank of Japan does not raise interest rates. Thus, exchange rates are moved by complex factors.

The Yen carry trade involves borrowing funds at low Japanese interest rates, selling Yen, buying dollars, and investing in overseas assets. This has led to a weaker Yen and a stronger dollar. However, when Japan repatriates overseas funds, it sells overseas assets and dollars to buy Yen, leading to the unwinding of the Yen carry trade. In this process, the Yen's value strengthens, and risks to risk assets may increase. Due to the experience of a massive Yen carry unwind in August 2004, which caused Japan's Nikkei index to plummet 13% in one day, Japan and the world harbor fears about the Yen carry trade.

As Japan raised interest rates and the U.S. lowered them, the interest rate differential between the two countries narrowed rapidly. The Yen carry trade is an investment that leverages this interest rate differential, but with Japan's interest rates rising and the Yen's value also increasing, the investment became unattractive. In this situation, a rapid unwinding of the Yen carry trade occurred. However, because of past experience, many conservative views suggest that the current interest rate hike cycle will not be a game-changer that significantly shakes the market.

If the Yen carry trade unwinding fully materializes, the process of selling overseas assets and buying Yen could lead to a stronger Yen and increased risk for risk assets like stocks. This could have a significant impact on financial markets. However, the market has learned a great deal from the experience of the Yen carry unwinding in August 2004. Thanks to this experience, there is a view that the next time, it is unlikely to suffer in the exact same way as in the past. Therefore, while the unwinding of the Yen carry trade is certainly a risk factor, it is currently believed that its potential should be viewed as limited.

Over the past few years, high expectations for AI have concentrated funds in AI-related big tech companies and infrastructure (power, semiconductors, etc.). However, with the recent significant rise in interest rates, it has become difficult to view AI solely as an intangible asset as in the past. The development of AI requires the construction of physical infrastructure like data centers and power supply infrastructure, demanding significant capital for tangible asset investment and facility investment. Big tech companies are also struggling to secure funds and are borrowing money. When interest rates were 0%, investment was relatively free, but when rates rise to 20%, one must carefully select investments that can generate returns higher than that. Therefore, there needs to be a shift in focus from intangible asset-centric investment to tangible assets.

As interest rates rise, the indiscriminate flow of funds into specific sectors is likely to diminish. Decreased liquidity, rising inflation, and increased uncertainty will make investors more cautious. Instead of concentrating in one area, funds may rapidly move between various sectors in a rotation. Therefore, investors should consider strategies that diversify their portfolios broadly. It is necessary to guard against overconcentration in specific sectors or regions and to consider diverse investments across asset classes.

Moreover, infrastructure capable of supplying power to these data centers is also crucial. Building such real economic infrastructure requires creating tangible assets and investing significant capital in facilities. In the past, when interest rates were 0%, money could be borrowed cheaply for investment, but as rates rise, the problem arises of having to carefully select investment opportunities that can generate returns exceeding the borrowed funds. This demands selective, high-yield investments instead of indiscriminate speculation.

In a situation where interest rates are high, market liquidity is shrinking, and inflation and uncertainty are increasing, the concentration of funds into specific sectors may decrease. Funds are more likely to circulate actively between sectors rather than being focused in one direction. Therefore, investors should consider ways to broaden their portfolios. It is necessary to guard against overconcentration in specific sectors or regions and also pay attention to assets that have received less attention recently, such as gold and bonds. Within stocks, attention should be increased for tangible assets like energy, infrastructure, and raw materials rather than intangible assets. This means adapting to a new investment environment with rising interest rates, moving away from an era where low interest rates were maintained for a long time.

In a situation where interest rates are high, market liquidity is shrinking, and inflation and uncertainty are increasing, the concentration of funds into specific sectors is likely to decrease. Funds are more likely to circulate actively between sectors rather than being focused in one direction. Therefore, investors should consider ways to broaden their portfolios. It is necessary to guard against overconcentration in specific sectors or regions and to consider diverse investments across asset classes.

It is necessary to pay a certain level of attention to asset classes that have recently fallen out of investor favor, such as gold and bonds. Within the stock market, while intangible assets were highly valued in the past, attention should now also be given to tangible assets like energy, infrastructure, and raw materials. This signals a demand for a shift in investment paradigms, as the era of prolonged low interest rates has ended and a new economic environment of rising interest rates is dawning.