Japan and the Fiscal Oil Slick
Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
While the Federal Reserve plays a dangerous game of chicken with the E.U. over who is going to fund the bailout and restructuring of Europe’s finances, while at the same time trying to bring Iran, Russia and China to heel with threats of sanctions for China and Iran and falling oil and ruble prices for Russia, Japan quietly sits back and allows the Yen to appreciate in the face of this; selling trillions of Yen in government bonds at very low coupons and gobbling up all the oil it needs at suddenly very reasonable prices.
No wonder the Nikkei 225 crested the 9000 level after bottoming near 8250 recently.
The price for both A-P Tapis and A-P Minas crude oil, the heavy and light crude grades of Southeast Asia, has dropped nearly 24% since the end of March. A-P Minas has fallen similarly, 25%. Both grades trade at a premium or discount to Brent Crude. The United States Brent Oil Fund (NYSEMKT:BNO) has fallen 24% since March 13th while the Maxis Nikkei 225 ETF (NYSEMKT:NKY) has fallen 8.7% and the Dow Jones Industrials only 2.6%.
When one factors in the 5.2% appreciation of the Yen versus the petrodollar, Japan is paying 30% less per barrel today than they were just three months ago. With a pair of their nuclear reactors going back on line this summer and their cutting back on oil imports to appease the U.S. over their policy towards Iran (May saw a 6.6% drop in the volume of oil imported), this will have an enormous effect on their balance of trade.
Factor in as well the change in their relationship with their biggest trading partner, China, bypassing the U.S. Dollar completely to settle trade, and the situation in Japan which continues to make headlines about how dire things are does not look as bad in the short term. The trade deficit from massive oil imports should mitigate this month and continue for as long as oil prices are under pressure from a fear of a global slowdown.
The longer oil prices remain low, the greater the effect on their manufacturing base to build competitively while their massive investments overseas in places like India, China and the ASEAN countries are being completed. The higher Yen is offset by a lower cost of goods sold. Once this wave of investment begins bearing fruit in the bottom lines of companies like Toyota, Bridgestone, Inpex etc. their budgetary problems will mitigate as tax revenues will rise and the debt servicing percentage, currently 21% of GDP, will begin to fall. The top 25 holdings of the iShares MSCI Japan ETF (NYSEMKT:EWJ) which comprise 39.1% of the fund’s AUM are trading is 20.8 times current earnings and 10.9 times projected 2012 yearend earnings.
Lost in all of the discussion about the size of Japan’s debt is the way it is structured. 2011 was the peak for the amount of JGB’s that had to be rolled over and they did so at far lower coupons than when they were issued originally. Guess what? 2012 is even better. This fear trade is the best thing that could have ever happened to the Japanese fiscal and economic situation.
The longer it goes on the stronger Japan and the rest of Southeast Asia will become, not only from the capital influx but also from the stronger local economic ties around the region. This is not some naïve decoupling argument, but rather an inflection point in the trend.
Whether that is enough to offset Japan’s age and debt bubbles, however, remains to be seen. In the medium term, overall, Japan is seeing the biggest net benefit to their fiscal and monetary situation due to the unfolding crisis in Europe. Shorting Japan at this point would not be wise. It’s a crowded trade that has had more than 20 years to unfold.
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