JAPANESE YEN FALLS ON WEAK ECONOMIC NEWS -- THAT'S HURTING JAPAN ISHARES -- SO IS FALLING GOLD PRICES -- THE FALLING YEN, HOWEVER, KEEPS CARRY TRADE GOING -- BOND YIELDS ARE STARTING TO RISE BUT REMAIN IN LONG-TERM DOWNTREND

JAPANESE YEN NEARS TEST OF OLD LOWS ... I wrote yesterday about weakness in foreign currencies pressuring gold. I focused on the Euro. However, the Japanese yen is falling much harder than the others. That has a lot of ripple effects -- some good, some bad. One is that it helps support the dollar, which is bad for gold. Another is that Japan has become one of the world's weakest markets. That may also be tied to gold. Let's start at the beginning. News of a first quarter slowdown in Japan has pushed the yen closer to its January low against the dollar (Chart 1). Weakness in the yen is pressuring Japan iShares (Chart 2) which are the day's weakest foreign ETF. That's because the EWJ is quoted in dollars instead of yen. A weak yen causes the EWJ to fall even further than the Japanese market (I'll show why shortly). Chart 3 shows the gold market falling again today (Chart 3). Notice the correlation between Charts 2 and 3. I've theorized that Japan is closely tied to gold. Let's review that idea.

Chart 1

Chart 2

Chart 3

JAPAN AND GOLD ARE LINKED ... Chart 4 overlays gold (solid line) over Japan iShares (bars). Notice the correlation. The blue line on top of Chart 3 is a ratio of the EWJ divided by the S&P 500. Japan has been underperforming the U.S. market since gold peaked last May. The recent selloff in gold coincides with another downturn in the EWJ/S&P ratio (see arrows). Why should that be? I've theorized in the past that Japan has been trying to emerge from a decade-long bout of deflation. In other words, Japan needs some inflation to continue its recovery. Gold is a proxy for inflation pressures. Japan has done much better since gold bottomed five years ago. Each time gold has stumbled, however, so has Japan. Like now. But there's more. Let's examine why the falling yen hurts the EWJ more than the Japanese cash market.

Chart 4

WEAK YEN HURTS EWJ ... Chart 5 compares Japan iShares (orange line) with the Nikkei 225 (blue line) since the start of 2006. They obviously trend in the same direction. But not at the same speed. You'll notice that the Nikkei 225 (blue line) exceeded last year's high, while the EWJ (orange line) didn't. The weaker performance of the EWJ is seen more clearly in the EWJ:Nikkie ratio below the price chart. The EWJ:Nikkie ratio has been dropping since last May. The reason is the green line, which is the Japanese yen. Notice that the two bottom lines rise and fall together. The explanation is this. The EWJ is quoted in dollars, while the Nikkei is quoted in yen. When the yen is strong, the EWJ does better. When the yen is weak (which has been the case) the EWJ underperforms the Nikkei (see arrows). Especially if gold is falling. I wrote yesterday that lack of leadership from gold shares is pulling gold lower. Weaker gold is causing Japan to underperform the rest of the world. The falling yen is causing Japan iShares to fall even faster than the Nikkei. [On April 12, I used this same analysis to explain why rising commodity prices were helping the Canadian stock market, and why a strong Canadian Dollar was causing Canada iShares (EWC) to rise even faster].

Chart 5

FALLING YEN KEEPS CARRY TRADE ALIVE... One of the potentially positive side-effects of a falling yen is that keeps the "yen carry trade' alive. That's based on the idea that global investors borrow the yen at very low rates (less than 1%) and switch into higher yielding currencies and assets. [In other words, they short the yen and buy the Australian Dollar among other things]. The yen carry trade has helped provide the liquidity that has kept the global stock market going. Chart 6 compares Emerging Market iShares (green line) to the yen/Australian Dollar trade (orange line). Each time the yen/Aussie line has jumped (spring of 2004 and 2006) emerging markets have sold off (see arrows). The same thing happened at the end of this February (see circles). That being the case, the falling yen may carry some good news for global markets.

Chart 6

COMMODITY PRICES IN HOLDING PATTERN ... I've been asked for an update on commodity prices. Chart 7 shows the Reuters/Jefferies CRB Index stalled below its fourth quarter highs and its 200-day moving average. The chart looks like a "right shoulder" in a "head and shoulders" bottom. The CRB, however, needs to close over the "neckline" (green line) to resume its uptrend. Contrast that with the CRB Continuous Contract (CCI) in Chart 8 which is much stronger. [That's because the CCI has a smaller energy weight than the CRB]. That stronger trend is confirmed by the DB Commodities Tracking Index (DBC) in Chart 9. The DBC is trading over both moving average lines and is nearing a test of 52-week high. Historically, commodity prices usually peak after stocks, not before. Therefore, the continuing bull market in stocks argues for higher commodity prices. So does the fact that the U.S. Dollar is still in a major downtrend. An important question is whether that combination will start to pull bond yields higher.

Chart 7

Chart 8

Chart 9

BOND YIELDS STARTING TO CLIMB ... It's no secret that one of the factors keeping the stock market rally intact is unusually low interest rates. In the past, the inflationary impact of rising commodity prices would have produced much higher bond yields by this point in the cycle. So far, that hasn't happened. But we have to stay vigilante just in case it does. That's why I'm showing the recent upturn in the 10-Year Treasury Note Yield in Chart 10. The rise isn't that serious. But it bears watching. Chart 11 puts the long-term trend of US Treasuries in better perspective. It shows the TNX still caught in a 13-year downtrend. Another round of rising commodity prices might be enough to push the TNX through that long-term resistance line. That would be a serious development. Just to bring things full circle, I also happen to believe that one of the factors keeping global rates unusually low is the remaining remnants of deflation in Japan. That's why I've always been intrigued with Chart 12. It overlays the Nikkei 225 over the trend of U.S. bond yields and shows a pretty close correlation. And, as we've just pointed out, Japan is tied to gold. Which brings us back to where we started this message.

Chart 10

Chart 11

Chart 12

MTA SEMINAR ON FRIDAY ... I'll be speaking at the Market Technicians Association (MTA) Annual Education Seminar in New York City tomorrow. As a result, there won't be a weekly wrapup this Friday. I doubt if things will change much anyway. Besides today's uptick in bond yields, the most notable feature was a jump in energy prices. That gave a big boost to energy shares which continue to set new highs. Energy has been the weakest part of the commodity world. New buying in the energy pits could energize the CRB Index which also rose today. It remains to be seen if rising bond yields, combined with rising oil, is enough to cause some profit-taking in an overbought stock market.