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Don't Bet Against the Bank of Japan

By    |   Monday, 03 November 2008 02:45 PM

This past week the Bank of Japan (BOJ) issued a warning that they may intervene "quickly" against the rise of the yen if the currency's rise continues.

Now, a lot of currency investors think the bank is blowing smoke when they release these warnings, as if they're only trying to scare the markets. But what the Bank of Japan is trying to do is give investors fair warning to correct the imbalance themselves. If they refuse to do so, the BOJ will go in with both guns loaded, as they have in the past.

I always laugh when I hear traders say that interventions aren't successful. Sure, when New Zealand's central bank intervened, it didn't know what it were doing and didn't have nearly enough in reserves to make a lasting impact.

However, the Bank of Japan has more in reserves than it has ever had before. It was also successful the last time it intervened in the USD/JPY exchange rate in March 2004 when they had fewer reserves than what they have now.

Traders say that interventions are unsuccessful because the point at which interventions happen aren't always the ultimate bottom. However, go back and look at the charts, and you will find that the USD/JPY exchange rate formed a "W" double-bottom pattern and headed higher for years afterwards.

So, the BOJ intervened at around 103.52 last time, and within two months the USD/JPY exchange rate was up to 115.00. I'd call that successful. However, here's where traders call it unsuccessful.

The rate then fell from around 115 down to 102 about nine months after the intervention. But the rate bottomed and went even higher from that point to almost 121, and then later on to 125.

So if you look at the bigger picture, the point at which they intervened was the start of a turnaround. It's just that currencies turn around like ships and not speed boats. But the BOJ did get its mission accomplished.

The one thing I like about the BOJ is that it isn't all talk. No, it will back up its talk by selling yen, especially against their two trading partners' currencies: the dollar and the euro.

It is very much concerned about these two exchange rates in particular. After all, a ton of the exports from companies such as Sony, Canon, Toyota, Isuzu, and Honda go to Europe and the United States. When the yen is strong against these currencies, it hurts major Japanese exporters.

The bank just won't sit idly by and watch some of its largest brands suffer for long. If the market doesn't turn these exchange rates around (USD/JPY, EUR/JPY), then the BOJ will do it for them. And this time, it even has the blessing of the G-7 behind it, according to a statement this past week.

You see, Canon has warned that the yen's advance against the dollar and the euro is "eroding their earnings." After all, the yen rose 14 percent against the dollar and about 30 percent against the euro in just one month. I've never seen that happen before in all of my years. But nonetheless, it is reality, and it's tearing Canon up one side and down the other.

Honda, Japan's second-largest auto maker, cut its operating profit forecast for their fiscal year by 13 percent. So, you can see that times are tough for these exporters. Not one of them has been immune to the onslaught brought on by the yen's rise.

This is why I have confidence in the USD/JPY and EUR/JPY exchange rates turning once again to the upside over time. You see, I don't have nearly as much at stake as Japan does. Japan won't let their "bread and butter" businesses go downhill over something it can control.

It's only a matter of whether the BOJ jawboning will be effective in persuading investors that are long the yen to close those out or if they will have to force them out by selling the yen and raising the pain threshold on them. Either way, it will happen, and you'll see the yen start its turn.

However, this will be a process that takes some months to ultimately complete. But the important part is to know that the process is starting even now.

After all, if I were long the yen and I heard this statement from the BOJ, I'd close out my longs because I wouldn't want to get caught on the wrong side of the market if they intervene and give back all of my profits.

I'd also be inclined to have a position against the yen after their statement. That way I know I'm investing with the bank and not against it. That way, if it intervened, it only brings me greater profits more quickly.

Obviously, I'm not the only one who comes to this conclusion. There's also a lot of other smart money out there (hedge funds managers, etc.) that will likely do the same.

This realignment will eventually turn the tide on the yen in the coming months. Those who are positioned properly will prosper handsomely over the coming months to year.

Just one final note for those of you who don't believe interventions can work. Go back on the EUR/USD chart and look at the G-7's intervention at 82.30.

Intervention talk should be taken seriously. In fact, Australia intervened in its dollar two days this past week. Knowing that, buying the AUD/JPY pair could also be beneficial. After all, you know the wishes of the central banks in both cases. And guess what? They eventually get what they want.

So if you invest with light margin (a low number of lots) so that you can hang on for some months, you will likely come out very well. Many currency investors leverage way too heavily and get margin-called out on a swing that their account can't handle and therefore they never get to enjoy the fruits of their analysis. Don't let this be you.

In extra-volatile times like these, I'd only invest one micro-lot per $500 in a micro-account or one-mini lot per $5,000 in a mini-account or one standard lot per $50,000 in a standard account.

When the volatility finally dies down and you are able to resume typical investing, then you can handle larger swings with one micro-lot per $250 or one mini-lot per $2,500 or one standard lot per $25,000. If you ever err to one side, make it the more cautious stance and not the more aggressive one. You'll never regret it.

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This past week the Bank of Japan (BOJ) issued a warning that they may intervene "quickly" against the rise of the yen if the currency's rise continues. Now, a lot of currency investors think the bank is blowing smoke when they release these warnings, as if they're only...
Monday, 03 November 2008 02:45 PM
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