MW-49 -- Gold or Equities; Which is the Real Bull Market?

J@pan Inc Magazine Presents:
Weekly Financial Commentary from Tokyo

Issue No. 49
Tuesday, October 21, 2003

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++ Viewpoint: Gold or Equities; Which is the Real Bull Market?
The Bottom Line:
Top-Down: Will the real bull market please stand up?
o Until fairly recently, some of the best minds in the financial
world were still fretting about deflation, not only in Japan
and China, but in the Western world as well. Meanwhile, the
CRB (Commodity Research Bureau) index had bottomed out in late
2001 and was staging a breakout of a massive bear market that
had persisted since the 1980s.

o Investors are only now realizing that this breakout means they
need to begin positioning their investments for future
inflation and secular outperformance of commodity prices
vis-・vis financial markets, particularly equities, and stop
fretting about deflation. If this supposition is true, the
rally in gold is the real bull market, as a precursor of the
next secular rally in commodity prices, the return of
inflation, and bond prices that properly discount a level of
structural inflation.

* Bottom-Up: What does this mean for investments in Japan?
o In Japan, individual investors and punters are back, and they
now account for more of total trading volume than foreign
investors. These are not the old geezers one used to see
hanging around the branches of Nomura or Daiwa securities, but
a younger "shinjinrui," or new generation of "plugged in"
investors, aggressively trading online through their PCs and
cellphones. This is giving a big boost to the surviving online
brokers in Japan, who at one point at the height of the bear
market were looking increasingly like an endangered species.

o As for yen-denominated assets versus commodity prices, gold
and other commodities could well continue to outperform
vis-・vis there respective US dollar-denominated values. In
terms of relative Topix subsector performance, a sustainable
rally in commodity prices as represented by the CRB index
could well drive significant performance in the oil/coal,
nonferrous metals and other pricing-dependent commodity
sectors in the Japanese market, as was seen during the past
two big rallies in the index during 1973-80 and 1992-96.

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++ Viewpoint: Gold or Equities; Which is the Real Bull Market?

Only a few months ago, some of the brightest minds in the world were
still fretting about deflation, including Alan Greenspan and the US
Federal Reserve.

But the CRB index, usually a good indicator of inflationary trends,
bottomed out in late 2001, and by late 2002, it had clearly broken up
out of a secular bear market from a massive peak in 1980.

Despite the historical inverse correlation between the CRB index and
US bond yields, Treasury yields continued to decline until midway into
2003. It was the sudden backup in long bond yields that caused
investors to realize that the US wasn't on the verge of falling into a
deflationary vortex, as the economy was actually beginning to show
signs of accelerating recovery.

Further evidence was given by the dramatic appreciation of what are
considered "resource-based" currencies in the trade-weighted US
dollar. Because of the "dirty floats" of other currencies (including
Japan) in the trade-weighted dollar index, the more freely floating
resource-based currencies such as the Australian dollar and the South
African rand bore a relatively higher burden of the depreciation of
the dollar against the currencies of its trading partners.

The recognized consensus now is that inflation, rather than deflation,
is the more likely probability. But given that the factors which
usually drive gold prices have historically been detrimental to equity
prices, the burning investment question is: Which is the "real" bull

We believe the bottom line is that inflation is back, and expectations
of higher inflation will mean a secular rise in global bond yields (as
bonds discount "sustainable" inflation) and a continued rise in
commodity prices. In other words, the next secular bull market will be
in commodity prices, not financial asset prices.

Yen Asset Prices and Gold
Everyone, it seems, recognizes the downward risk in the US dollar and
US dollar assets. But that is precisely one of the arguments for yen
assets, along with the fact that Japanese equities have been the Rip
Van Winkle of equity markets for the past 10 years. But if we are
indeed at the cusp of a major secular bull market in commodities, how
will yen assets fare?

As has been pointed out in prior newsletters, the price of gold has
been appreciating against *all* major currencies, not just the US
dollar. What this implies is that commodities as an asset class are
beginning to outperform all financial assets. Thus while the yen could
surge beyond 100/$1 because of a botched "strong dollar policy"
adjustment to get the Chinese yuan and Japanese yen realigned against
the US dollar, commodity prices, of which gold is a leading indicator,
could well do even better in relative terms.

In terms of relative sector performance, this implies that the
long-neglected basic materials sectors in the Japanese market are due
for a period of substantial performance. In the past two instances in
recent history when the CRB index staged a large rally, both the
oil/coal sectors and the nonferrous sectors outperformed the Topix.
During the 1973-80 period, aided by two oil "shocks," the Topix
oil/coal sector soared 7.3-fold, while the nonferrous sector jumped
2.3-fold, compared with a doubling of the Topix index. During the
1992-96 rally in the CRB index, the oil/coal sector jumped 56 percent,
while the nonferrous sector rose 59 percent. Topix's trough-to-peak
gain was 54 percent.

Recent Dow Jones performance in the US continues to show a strong
preference for mining, metals and basic materials, a trend reminiscent
of past rallies in the CRB index. In Japan, the relative performance
of the nonferrous sector has accelerated over the past month,
recording relative performance that is about twice that of the Topix.

-- Darrel Whitten

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Written by Darrel Whitten

Edited by J@pan Inc staff (


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