Life has a way of throwing lemons when you least expect it. While markets were grappling with the euro zone debt crisis and the political turmoil in Libya, news about a massive 8.9 earthquake in Japan took everyone by surprise.
Since then, the spotlight has remained focused on Japan. I feel like there’s so much more about this crisis than just the yen. So for a change, let’s see take a look at commodities and equities markets and how the crisis in Japan could affect them.
Commodities: Down, Down, then… Zoom!
Alright, first up is the commodities market. The effect of the Japanese earthquake-tsunami-nuclear crisis on commodities will likely be two-fold.
At first, commodity prices will probably take a hit as Japan’s seaports and infrastructure prevent goods from coming in. Demand will falter as people focus more on repairing the huge damages and make construction and manufacturing sites at least operational.
But as things settle down and stabilize, commodity prices will begin to rise. Once the damages are mended, demand will surge since people need to be fed, and the rebuilding of the larger structures will require huge amounts of raw materials and energy.
According to the International Energy Agency (IEA), Japan would need to use a mix of crude oil, liquefied natural gas (LNG), and thermal coal to fulfill its energy needs. These three commodities were in huge demand back 2007 after one of Japan’s biggest nuclear plants were closed.
Equities: It’s ALL About Risk Sentiment!
Many were stunned to see the index fall about 6% on Monday, and I’m sure countless jaws hit the floor when Nikkei plunged over 10% the following day.
But if you think about it, we shouldn’t really be so surprised to see such a reaction from the stock market. It was only natural. Being a risk-sensitive asset class, equities or stocks tend to move violently in response to such catastrophes.
With that in mind, how the equities markets will perform over the coming days will really depend on risk sentiment. Fundamentals will probably take a backseat in the meantime.
Now, I’ve seen my fair share of disasters, and from my experience, we’ll probably see Japanese stocks continue to slide just as they did back in 1995 when the great Kobe earthquake struck.
Since there’s a lot of uncertainty surrounding Japan, we’ll likely witness further unwinding of carry trades. Of course, if you read the School of Piposology’s lesson on carry trades, you would know that risk aversion can cause investors to unwind their carry trades, or sell their riskier assets (such as stocks) in exchange for safe haven assets (such as the yen).
However, the effects of the earthquake aren’t limited to Japan’s stocks. Because of the severity of the damage, and because we’re dealing with one of the largest economies (third largest in the world, baby!), you can expect other countries’ equities to be affected by this disaster as well… although it probably won’t have as big an impact on other countries’ equities compared to Japanese stocks.
Now you might be thinking, “I only trade currencies. I don’t need this!”
Wait, stop right there. Ask all the cool cats who have gone through the School of Pipsology because they know that financial markets are interrelated.
If you were familiar about the relationship of the Nikkei and USD/JPY, you probably were able to reel in some pips when you went short as soon as news of nuclear explosions in Japan hit the airwaves.
If you’re still wondering why short was the way to go, you may want to check out our Intermarket Analysis Cheat Sheet to help you better anticipate the yen’s moves this week!