Post From Sovereign Man Simon Black
Here’s What’s Happening With The Chinese Currency Currently
By Tim Staermose
At the end of last year, most market pundits and investors believed that a steady, gradual appreciation of the Chinese currency (the yuan, or the renminbi) versus the US dollar was the most likely scenario as China continues its inevitable march towards being the preeminent global economic power.
Since early 2014, however, I’ve been identifying indicators that point to a signifcant downturn in the Chinese economy. And that to me presented an incredible speculative opportunity that that we could all profit from.
~~~
Here’s What’s Happening With The Chinese Currency Currently
By Tim Staermose
At the end of last year, most market pundits and investors believed that a steady, gradual appreciation of the Chinese currency (the yuan, or the renminbi) versus the US dollar was the most likely scenario as China continues its inevitable march towards being the preeminent global economic power.
Since early 2014, however, I’ve been identifying indicators that point to a signifcant downturn in the Chinese economy. And that to me presented an incredible speculative opportunity that that we could all profit from.
~~~
It was obvious that China’s economy was in for serious trouble:
First corporate defaults started happening. Capital started feeing the country en masse, and indeed the Chinese government’s foreign exchange reserves started shrinking.
Industrial production growth has slowed down markedly, as has trade—exports shrank by 14.6% from a year earlier in March. Imports also slid 12.3%. For an economy as reliant on trade for its growth engine as China, that’s a huge drag on performance.
Chinese real estate prices are down on average 5.7% countrywide versus a year ago.
GDP growth has slowed substantially from previous years. The International Monetary Fund (IMF) now projects that Chinese growth will slow to 6.8% in 2015, and 6.3% in 2016.
To prop up growth, the Chinese government engineered a huge stock market bubble earlier this year, which spectacularly collapsed a few months ago.
Despite all of this, there is a MAJOR disconnect between the Chinese economy and the Chinese currency
Typically, when an economy suffers, the currency suffers with it. Look at Australia, Russia, Turkey, South Africa etc. Each of these countries is in serious economic pain, and their currencies have declined accordingly.
But that hadn’t happened yet in China when I first made this observation. The Chinese renminbi was still trading more or less in a ‘normal’ range thanks to government intervention to prop the currency up.
That signaled a major speculative opportunity to bet on a decline in the renminbi. It was impossible to know -when-, but eventually, the government would run out of ammunition and devalue the currency in accordance with the economic slowdown.
Bets like these are always difficult to make; you can get the premise right, and the timing wrong.
Would the Chinese government devalue in a month? Six months? A year? It was impossible to say, which is why we categorized this a ‘high risk, high return’ speculation.
But the short-term case against China continues building as the numbers get worse.
Virtually every single economic indicator shows that China is experiencing serious pain.
My thesis that the slowing Chinese economy and capital fight would cause so much pain that the yuan would have to weaken proved to be correct. Indeed, the Chinese authorities took most of the market by surprise in mid-August and devalued the yuan by several percent, which was a huge move.
It shook the markets badly. A mild panic ensued, and I think the Chinese got spooked. They were not expecting so much money to try and rush out of China.
As a result, they baulked. Even though they clearly would like to engineer a weaker yuan, they got scared of the consequences.
Because what’s driving the Chinese authorities right now, in the short term, has little to do with economic fundamentals. Instead, it’s the on-again, of-again, debate about whether China’s currency should be included in the IMF’s SDR basket.
Remember, SDR (Special Drawing Rights) is IMF’s currency that doesn’t exist in physical form (i.e. it’s a digital currency) and that can only be used by governments and central banks. It’s like their own monopoly money.
The value of the SDR is composed of the values of currencies in its currency basket. There are currently four of them: the US dollar, the euro, the British pound, and the Japanese yen. In the financial world this gives these four currencies some extra credence, since they have the seal of approval from the IMF. They’re considered reserve currencies, and most central banks around the world hold some portion of them.
Every five years the IMF reviews the SDR’s currency basket composition. The next review is about to happen by the end of the year.
There haven’t been any changes to it in a long time, but with China’s rapid rise and its importance in the global economy, the Chinese yuan is increasingly banging on IMF’s door. And they can’t ignore its ascendance much longer.
The Chinese authorities crave for the yuan to be included in the SDR currency basket. They see it as their acceptance to the Big Boys Club. (Even though at the same time they’re hedging their bets and building a parallel international financial architecture that doesn’t rely on the West.)
Having earlier in the year said that it would not be possible to include the yuan this time around, some IMF stafers back-flipped, and are now recommending that the yuan be included after all.
Seizing on this possibility, the Chinese authorities are desperately trying to keep the yuan stable until the final decision is handed down, and impress the IMF by reducing capital controls (even though they have simultaneously increased them elsewhere).
An announcement is expected before the end of the year, after an IMF board meeting considers the issue some time in November. But any change to the SDR basket would not come into effect until October, 2016.
You can read the IMF’s not-so-cryptic message about it on its website, here:
http://ift.tt/1LwBqOD
It seems to me there is a lot of political horse-trading going on behind the scenes over this issue. And no one knows what’s going to happen in the end.
This has left the currency in limbo.
So for now the best thing to do is wait.
Options are funny beasts in that their prices are heavily affected by volatility, sentiment, and news.
Right now we don’t see an obvious BUY in the options market. I’d expect this will open up pending (a) the IMF decision, and (b) what happens with the US interest rate decision next month.
So we’ll have more to report soon. There will likely be several more recommendations before this trade runs its course. We want to be very clear—some will win, others will lose.
So far we’ve had one recommendation in this trade up as much as 450%. Another was down 56%. And a few have expired worthless for a 100% loss.
First corporate defaults started happening. Capital started feeing the country en masse, and indeed the Chinese government’s foreign exchange reserves started shrinking.
Industrial production growth has slowed down markedly, as has trade—exports shrank by 14.6% from a year earlier in March. Imports also slid 12.3%. For an economy as reliant on trade for its growth engine as China, that’s a huge drag on performance.
Chinese real estate prices are down on average 5.7% countrywide versus a year ago.
GDP growth has slowed substantially from previous years. The International Monetary Fund (IMF) now projects that Chinese growth will slow to 6.8% in 2015, and 6.3% in 2016.
To prop up growth, the Chinese government engineered a huge stock market bubble earlier this year, which spectacularly collapsed a few months ago.
Despite all of this, there is a MAJOR disconnect between the Chinese economy and the Chinese currency
Typically, when an economy suffers, the currency suffers with it. Look at Australia, Russia, Turkey, South Africa etc. Each of these countries is in serious economic pain, and their currencies have declined accordingly.
But that hadn’t happened yet in China when I first made this observation. The Chinese renminbi was still trading more or less in a ‘normal’ range thanks to government intervention to prop the currency up.
That signaled a major speculative opportunity to bet on a decline in the renminbi. It was impossible to know -when-, but eventually, the government would run out of ammunition and devalue the currency in accordance with the economic slowdown.
Bets like these are always difficult to make; you can get the premise right, and the timing wrong.
Would the Chinese government devalue in a month? Six months? A year? It was impossible to say, which is why we categorized this a ‘high risk, high return’ speculation.
But the short-term case against China continues building as the numbers get worse.
Virtually every single economic indicator shows that China is experiencing serious pain.
My thesis that the slowing Chinese economy and capital fight would cause so much pain that the yuan would have to weaken proved to be correct. Indeed, the Chinese authorities took most of the market by surprise in mid-August and devalued the yuan by several percent, which was a huge move.
It shook the markets badly. A mild panic ensued, and I think the Chinese got spooked. They were not expecting so much money to try and rush out of China.
As a result, they baulked. Even though they clearly would like to engineer a weaker yuan, they got scared of the consequences.
Because what’s driving the Chinese authorities right now, in the short term, has little to do with economic fundamentals. Instead, it’s the on-again, of-again, debate about whether China’s currency should be included in the IMF’s SDR basket.
Remember, SDR (Special Drawing Rights) is IMF’s currency that doesn’t exist in physical form (i.e. it’s a digital currency) and that can only be used by governments and central banks. It’s like their own monopoly money.
The value of the SDR is composed of the values of currencies in its currency basket. There are currently four of them: the US dollar, the euro, the British pound, and the Japanese yen. In the financial world this gives these four currencies some extra credence, since they have the seal of approval from the IMF. They’re considered reserve currencies, and most central banks around the world hold some portion of them.
Every five years the IMF reviews the SDR’s currency basket composition. The next review is about to happen by the end of the year.
There haven’t been any changes to it in a long time, but with China’s rapid rise and its importance in the global economy, the Chinese yuan is increasingly banging on IMF’s door. And they can’t ignore its ascendance much longer.
The Chinese authorities crave for the yuan to be included in the SDR currency basket. They see it as their acceptance to the Big Boys Club. (Even though at the same time they’re hedging their bets and building a parallel international financial architecture that doesn’t rely on the West.)
Having earlier in the year said that it would not be possible to include the yuan this time around, some IMF stafers back-flipped, and are now recommending that the yuan be included after all.
Seizing on this possibility, the Chinese authorities are desperately trying to keep the yuan stable until the final decision is handed down, and impress the IMF by reducing capital controls (even though they have simultaneously increased them elsewhere).
An announcement is expected before the end of the year, after an IMF board meeting considers the issue some time in November. But any change to the SDR basket would not come into effect until October, 2016.
You can read the IMF’s not-so-cryptic message about it on its website, here:
http://ift.tt/1LwBqOD
It seems to me there is a lot of political horse-trading going on behind the scenes over this issue. And no one knows what’s going to happen in the end.
This has left the currency in limbo.
So for now the best thing to do is wait.
Options are funny beasts in that their prices are heavily affected by volatility, sentiment, and news.
Right now we don’t see an obvious BUY in the options market. I’d expect this will open up pending (a) the IMF decision, and (b) what happens with the US interest rate decision next month.
So we’ll have more to report soon. There will likely be several more recommendations before this trade runs its course. We want to be very clear—some will win, others will lose.
So far we’ve had one recommendation in this trade up as much as 450%. Another was down 56%. And a few have expired worthless for a 100% loss.
I expect we will have one or two more big wins before this story plays out, as well as a few more that are 100% losers. It’s important to know that going into these trades—as always, only make high risk speculations with small bite sizes that won’t dent your personal financial situation.
No one has a crystal ball and can predict exactly when the yuan will weaken. But all the evidence continues to suggest that it will.
In the long term, China will inevitably displace the US as the biggest and most important economy, and the renminbi will likely replace the US dollar in importance globally as a result.
But in the short term, the Chinese economy is in trouble after unprecedented growth and even greater credit creation have slowed.
We’re betting that the currency will follow.
If you’re short the yuan via other trades that don’t have a time limit, for instance via the Investors Europe FX trading platform, or Saxo Bank’s FX options offerings, which I have also pointed non-US Persons toward, I definitely recommend that you HOLD your position.
China’s economic fundamentals continue to deteriorate and a weaker currency is one policy tool the authorities will eventually use to try and stem the bleeding, when it gets painful enough.
But, for now, it’s best to stand aside and let the IMF SDR inclusion issue be decided on first, before we look to come back for another crack at profiting from the yuan devaluation.
Yours in Freedom, Tim Staermose
Chief Investment Strategist Sovereign Man
www.sovereignman.com
SMC ALERT: November2015 SURVIVE AND THRIVE IN THE AGE
No one has a crystal ball and can predict exactly when the yuan will weaken. But all the evidence continues to suggest that it will.
In the long term, China will inevitably displace the US as the biggest and most important economy, and the renminbi will likely replace the US dollar in importance globally as a result.
But in the short term, the Chinese economy is in trouble after unprecedented growth and even greater credit creation have slowed.
We’re betting that the currency will follow.
If you’re short the yuan via other trades that don’t have a time limit, for instance via the Investors Europe FX trading platform, or Saxo Bank’s FX options offerings, which I have also pointed non-US Persons toward, I definitely recommend that you HOLD your position.
China’s economic fundamentals continue to deteriorate and a weaker currency is one policy tool the authorities will eventually use to try and stem the bleeding, when it gets painful enough.
But, for now, it’s best to stand aside and let the IMF SDR inclusion issue be decided on first, before we look to come back for another crack at profiting from the yuan devaluation.
Yours in Freedom, Tim Staermose
Chief Investment Strategist Sovereign Man
www.sovereignman.com
SMC ALERT: November2015 SURVIVE AND THRIVE IN THE AGE
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