Alright so I’ve realized a new trade that I want to start making.

Which is – borrowing yen around ~1.5%/yr and buying gold with it.

Getting burned by the yen / US-treasury carry, I am a bit unsure about if there are any pitfalls I missed, but let me write the post to consolidate my logic.

Disadvantage of the US treasury carry-trade

So the first time I went with US treasury carry-trade, the big risk was yen gaining strength against the USD.

And in a doomsday scenario where USD is worth 0, I’d be short infinite amount of yen in USD terms and can never repay my shorts.

Barring such doomsday scenario, if the USD debase faster than the yen, which can happens both in short term or long term, this would still be a losing trade.

Not to mention the liquidity risk I have to carry.

So in hindsight this is a potentially very profitable trade if the USD strengthens but also comes with decent risks.

Benefit of the Gold carry-trade

Now let’s consider the gold carry-trade.

There is no “other currency” risk.

The basic story is, if yen depreciates or debase, this trade wins. If the yen gets so strong and go as far as being able to devalue gold, this trade loses.

And well, is there any world in where the yen can appreciate against gold in the medium or long term?

My answer would be, no.

The demand for gold can shrink, sure. And in the 2010-2015 period we see a sharp drop in Gold’s value in USD terms.

But in fact nothing happened with gold. The dollar just got really strong.

In the same period, gold prices stayed constant against JPY.

And in no period in recent history has the gold price drop against JPY in any significant manner.

Logically it can’t quite happen either as long as the BOJ keeps printing.

My personal hedge for this trade

With my investments my ultimate goal is to get a nice home in Tokyo and live comfortably.

And with home prices shooting up in tokyo, I have felt like I’m getting poorer even in spite of the decreasing yen.

The housing prices have gone up more than the yen has depreciated – which is just showing that, the USD has also weakened and debasement is eating away at BOTH currencies.

USD has fared better than JPY in the recent few years but in the recent months it’s been changing. This trend can definitely change which makes it even more dangerous for me earning and holding USD.

So the gold-yen carry actually serves well as a hedge against purely yen debasement and using margin makes sense since I’d want to use margin for the home purchase as well.

Risks of the Gold carry-trade

So obviously the price of gold can drop, either because the demand and strength of the yen increase, or the demand and strength of gold weaken.

Let’s look at the two separately.

Yen strength is based on demands for japanese exports and also the money supply of yen.

• With continuous QE in Japan that probably won’t slow too much, it would be difficult to see the money supply decreasing.
• Also with the trade deficit and the digital deficit, the demand for japanese exports shouldn’t really increase that much, if any.

Gold’s strength is based on the need for gold as a currency of exchange, or the weakness of the prominent world reserve currency, USD.

• If USD strengthens people will sell their gold to buy USD, reducing demand and pushing down gold. However, in such case people should also be selling yen to buy USD, so the yen-gold price shouldn’t be affected greatly.
• As shown from mid-2012 until end of 2015, gold price had a ~40% drawdown against USD, but only a <10% drawdown against YEN.

In recent 20 years history, seems like the biggest drawdown of GOLD-JPY is around 20% over a period of 1 year or so.

So let’s take that as the benchmark for the risk potential – 25% drawdown maximum, and allocate so that I wouldn’t have liquidity problem even if that happens (which it likely won’t anyways).

10% drawdown is typical as well and the amount should be within range so that a 10% drawdown doesn’t really “hurt” per se.

For now, I am thinking to start out around 5% portfolio, or around ¥2M borrowed to buy gold. Let’s see if it goes well I might increase to 10% or even more.