Successful futures traders often use different markets to forecast changes in the markets they are trading. The ability to identify correlated assets and recognize market leaders often gives traders an edge. Since 2016, the gold futures and Japanese Yen/USD exchange rate have exhibited a high correlation.
As you can see in the chart below, the Yen/USD exchange rate (in black) and Gold markets (blue line) have been moving in virtual lock step for the past few years.
While this correlation appears to have weakened slightly the last 3 months, with gold slightly outperforming the Yen, the trend remains relatively strong. Technical traders should keep an eye on these markets for new opportunities.
The reasons behind this correlation are purely speculative, but my theory traces back to something called the carry trade. In executing a carry trade, investors borrow in a currency with low interest rates, and convert and invest in a currency with higher interest rates to take advantage of the relative difference between the two. In this case, the Japanese interest rates are less than the US interest rates, so carry traders have borrowed in yen, converted to dollars and invested in US interest rate products. In borrowing Yen and buying dollars, carry traders create a short exposure to JPY/USD exchange rates: they will eventually have to convert back to Yen to repay their loans, and if the Yen strengthens vs. the Dollar in the meantime, they face potential losses that could eat into their Dollar denominated investment profits. As the Yen strengthens against the dollar, carry traders may be buying gold to hedge against these exchange rate changes. This may explain the high correlation we’ve seen.
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Futures and options trading involve significant risk of loss and may not be suitable for everyone. Therefore, carefully consider whether such trading is suitable for you in light of your financial condition. The risk of loss in trading futures and options can be substantial. The views and opinions expressed in this letter are those of the author and do not reflect the views of ADM Investor Services, Inc. or its staff. Research analyst does not currently maintain positions in the commodities specified within this report. The information provided is designed to assist in your analysis and evaluation of the futures and options markets. However, any decisions you may make to buy, sell or hold a futures or options position on such research are entirely your own and not in any way deemed to be endorsed by or attributed to ADMIS. Copyright © ADM Investor Services, Inc.
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The risk of loss in trading futures and options on futures can be substantial. Each investor must carefully consider whether this type of investment is appropriate for them. Past performance is not necessarily indicative of future results.