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Saw this post on InvestingMinds. Pretty interesting strategy. You don’t hear anything about a Yuan carry trade strategy. However, I’ve been long the Yuan for a while because I believe that the Chinese can’t continue to hold it down forever. I think that’s the risk with your strategy - i.e. they let it appreciate much faster.

Bryan - Gary raises two interesting questions which I’d appreciate your thoughts on.

1. I’ve read several pieces mentioning the Yuan rising anywhere from 5 to 10% in 2008. Do you have any thoughts/opinions on this?

2. Gary mentioned being long the Yuan. For those of us who are not currency trading “aficiandos” - what investing mechanisms would you recommend to get long the Yuan?

Thank you,
Mark

Mark,

I’ve invested in the Yuan through a World Currency Account at EverBank. It doesn’t pay any interest but if you are as bullish on the Yuan as I am that’s not a problem. You can read my bullish case in an old blog post here: http://www.investingminds.com/social/blogs/gary/index.php?pst_id=100004

Thank you both for your comments.

My thoughts on the Chinese Yuan continue to remain the same and that is why I use it as the borrowing currency for my carry trade portfolio. While it is common knowledge that the Yuan will continue to appreciate in value versus the Dollar (which if you have a Yuan-denominated bank account, this will benefit you, especially if the Yuan appreciates more than 5% this year), receiving the positive interest rate differential of 8.62% for holding the USD/CNY pair long more than enough compensates me for the risk of Yuan appreciation.

Mark, to answer your first question, my belief is that the Chinese will only allow their currency to appreciate 6% which is just a little above the US inflation rate. What this does is it allows Chinese goods to keep their competitive advantage in the US, improve their economic standing by increasing purchasing power, and it keeps the US politicians off of its back (for the most part). Anything greater than 6% would have an adverse effect on the Chinese because the majority of the Chinese foreign exchange reserves are in Dollars and they are only generating about 5% in interest per year. Another fact that politicians forget about is that the Chinese are the biggest buyers of US Treasuries, and the only reason for issuing Treasuries is to finance government debt. The US politicians are biting off the one hand that has supported their huge deficit spending over the past couple years.

One of the strategies that I am going to look at in the future is if this strategy of shorting the Yuan against the above currency basket combined with owning Chinese stocks (ie indirectly going long Chinese Yuan) offers a decent hedge.

Thanks for visiting!

Bryan

Thank you both - Bryan and Gary for your replies.

Gary - if I understand correctly, you have a Yuan invested CD with EverBank that pays 0% interest. Any gains you make on such come from the Yuan’s appreciation versus the US dollar. So, if the Yuan appreciates 5% versus the US dollar in 2008, your gain would be 5%. Yes/No?

If I’m correct - how much do you expect the Yuan to appreciate in 2008 - as you could lock in 5+% in US CDs at IndyMacBank and other?

Bryan - with regards to your looking into a strategy involving owning Chinese stocks - any fear of a Chinese stock market meltdown? I believe the Chinese market is down around 20% from its recent highs - but contrary to popular opinion - I’m of the belief that if the US gets hit with a recession, the rest of the world will be hurt as well, including China.

Thank you,
Mark

Yes, the Yuan return for me is totally based upon the appreciation and maybe I’ll get a 5% return if things continue like they are. Not great. However, some people believe that the Yuan might be as much as 30% undervalued. I don’t think that will get fixed over night but I do think at some point the Chinese will start to let the Yuan appreciate faster than 5% per year for all the reasons I point out in my blog post. It might go to a 10 or 15% rate.

Bryan - what effect would you expect with regard to the Yuan if the Chinese stock market dropped another 20%, 50%?

E.g. Would you expect the Yuan to appreciate/depreciate/stay the same (with respect to the $USD) if the Chinese stock market goes down another 20%? What about a decline of 50%?

Thank you,
Mark

Mark,

I feel China is immune from a crash as large as that, and the reason to draw that conclusion is the government would most likely come in and protect the market from going into crisis. Any weakness in the economy (ie. stock market performance) could be a reflection of the government and the people will begin to second guess the policies made by their government over the past few years.

If there is any weakness in the currency, the government will most likely continue to support the “floating” peg, as any shock in the currency market could have a drastic effect on the exporting nature of their economy.

Bryan

Hi Bryan,

Excellent work with your research. I had invesed in the EUR/TRY vs. EUR/JPY ad the USD/TRY vs. USD/JPY

I had been re-investing all interest gains monthly.
The initial amount was $4000.00 CDN.

I was at $8,300.00 in August. (20:1 margin used)

The jump in the EUR/TRY and fall in EUR/JPY left me with a margin call.

I am now trying the carry trade basket and reinvesting the monthly interest. The numbers are too good. if I can find a stable currency basket with the interest required and reinvest monthly it will make for a very good investment.

Any thoughts?

Joel

Forgot start date

I was at $8,300.00 August 15th, started in May (20:1 margin used)

Joel

China is doing really well latly (if you minus the excessive pollution and recent earthquake) I hope thier economy continues to grow despite the recent hardships.