Down With the Yen

08/26/2009 10:44 am EST

Focus: GLOBAL

Carlton Delfeld

Editor, The La Jolla Letter and Pacific Gains

Japan's currency is living on borrowed time just like its lame-duck government, writes Carlton Delfeld in Chartwell Global ETF Report.

The Japanese economy is unfortunately mired in its worst economic contraction in 35 years and a recession that may be the worst in 50 years. According to Japan’s Ministry of Finance, the country’s industrial production and exports may fall 30%, and its gross domestic product could drop as much as 10% in 2009.The national debt as a percentage of GDP is headed for 200%.

Paradoxically, the Japanese yen, along with the US dollar and Swiss franc, have done well since the financial crisis broke, being perceived as both a liquid and safe haven in the storm. But given the price that Japanese exporters are paying, Japan’s close-to-zero interest rates, and the country's demographic and high-debt/slow-growth trajectory, I expect a reversal.

Toyota is experiencing its first losses since 1938, as every digit of yen appreciation results in an additional $450 million in operating losses. In addition, Japan no longer runs much of an overall trade or current account surplus. If you exclude the trade position involving cars, Japan has run a deficit [of up to] 2% of gross domestic product for the past 18 months. 80% of Japanese manufacturing now takes place offshore.

Furthermore, Japan’s once sky-high household savings rate has continuously slowed and is now a measly 2% as an aging population earns less and digs into nest eggs. In fact, the US household savings rate is now double that of Japan! On the portfolio side, the flows are also out of Japan. There has been a steady net outflow in terms of overall portfolio flows of bonds and stocks.

The ProShares Ultra Short Yen (NYSE: YCS) seeks a return of -200% of the return of a benchmark (target) for a single day (before fees and expenses). Due to the compounding of daily returns, returns over periods other than one day will likely differ in amount and possibly direction from the target return for the same period.

The upcoming August 30 election will see the once mighty LDP fall from power and a growing focus on Japan’s financial weakness. As the global economy stabilizes, Japan’s attraction as a so-called safe haven will diminish and investors will likely seek higher-yielding currencies.

Consult your financial advisor first, but perhaps another way to play a weaker yen is to buy a put option on the CurrencyShares Japan Yen Trust (NYSE: FXY) ETF. The risk factor is high and I suggest an 8% to 10% trailing stop loss.

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