How gold benefits from turmoil in Japan that is gripping Wall Street

For years, Japan was a paradise for investors who knew where to look. For decades, interest rates were around zero, and sometimes even below, as a result of the central bank's extremely generous policy. As a result, the Japanese yen grew into the financing currency of the global financial system.

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Investors were able to borrow cheaply in yen, exchange that money to dollars or euros, and invest in higher yielding assets. As long as the yen remained weak, that strategy worked almost silently in the background.

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This mechanism is known as the Yen Carry Trade. In this article, we explain how this strategy works, why it is now under pressure, and why the gold price benefits from this.

The Yen Carry Trade explained in five steps

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1. Borrowing in Japan: An investor borrows money in Japan, in yen, at an extremely low interest rate. This can be done via banks, the bond market or derivatives.
2. Selling yen: The borrowed yen is sold directly on the foreign exchange market and converted to another currency, often the dollar or euro.
3. Investing in higher yielding assets: With those dollars, the investor buys assets with a higher expected return, such as US government bonds or stocks.
4. Just wait and see: as long as the interest rate differential between Japan and the rest of the world remains large and the yen does not rise, this strategy will continue profitably. After all, the investor gets a return, while the financing costs remain low.
5. Time for the exit: when the investor wants to quit, he sells the investment, exchanges the dollars back to yen, and repays the loan.

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The weak spot in this story is clear: this strategy only works as long as the yen does not strengthen. As soon as doubts arise about the weakening of the Japanese yen, doubts arise about the Yen Carry Trade. That's exactly what we're seeing happening right now.

Why the carry trade is now under pressure

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The conditions that made the Yen Carry Trade so attractive for years are changing.

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First, Japanese interest rate policy is slowly changing. tilting. The central bank has said goodbye to negative interest rates and is cautiously leaving more room for higher long-term interest rates. This makes borrowing in yen less obvious than before.

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Second, the yen is extremely weak been. That sounds attractive for carry traders, but it actually increases the risk. The further a currency continues to advance, the greater the chance of a sharp counter-movement.

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Thirdly, worldwide, the unease toe. In periods when investors become more defensive, the willingness to take risks with borrowed money decreases. Carry trades are then phased out, often at the same time.

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This potentially sets off a chain reaction: investors buy yen back to close their positions, the yen continues to rise, and that puts pressure on other carry trades again.

What this means for Wall Street

The Yen Carry Trade is not a Japanese problem. It is deeply intertwined with global capital markets. A sudden phasing out affects:

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• US stocks
• bond markets
• risk investments

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When those positions come under pressure, volatility rises and the demand for safe havens increases. And that's where gold comes into the picture.

Why gold benefits

Gold benefits not because Japan is in trouble, but because confidence in financial structures is declining. When:

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• currency suddenly move
• interest rate differentials become uncertain
• leveraged positions are being reduced

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In that case, investors look for assets without counterparty risk. Gold has no issuer, no credit risk, and no dependence on monetary policy.

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All of this does not mean that we are on the verge of a financial crisis. Extreme scenarios are rarely the most likely. What it does mean is that a pillar of stability under the markets for years is starting to move. And as soon as such fundamentals shift, capital repositions.

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In such an environment, it is logical that investing in gold comes back into the picture more emphatically. Not as a quick trade, but as insurance in a world where securities are slowly becoming less obvious. Just like from the geopolitical uncertainty, gold is also benefiting from the uncertainty about the potential settlement of the Yen Carry Trade.