Opportunity in the Brazilian Real and Chinese Renminbi

Since investing in foreign currencies is a critical component of our global macro investment strategy, we would like to present you with a few ideas and updates every quarter. In this issue we look at two of the most promising foreign currency investments that we hold: The Chinese Renminbi and the Brazilian Real. We think foreign currency exposure should be treated as a separate value driver in a portfolio since its impact on investment performance is significant and often bigger than the performance of the underlying security when the exposure is taken by buying stocks or bonds.

Among the most attractive long-term opportunities we see are investments in the Chinese Renminbi and the Brazilian Real. Both economies are, in our view, in a long-term economic uptrend, albeit for different reasons. The Chinese economy is still growing at around 8% per year and its pace has only slowed marginally during the last couple of quarters, despite the global recession. This success can be attributed to the Chinese Central Bank and the government, which have reacted very swiftly by providing the necessary liquidity and an enormous amount of investment spending.

There is increasing evidence that China and Asia’s business cycles are becoming increasingly independent and less correlated to the rest of the world. China, long known for its primary strength as a low cost producer for all kinds of products is now also becoming interesting as a market for selling products. Its rising significance is evident in the fact that it has surpassed the U.S. as the most important sales region for cars and a rapidly increasing number of people moving up to the middle class will mean more and more purchasing power for Chinese consumers.

Brazil is as interesting but for different reasons. Brazil’s economy has grown strongly in recent years and it possesses huge quantities of just about every commodity there is. The Brazilian Real, originally introduced in the early 90’s, hit a historical low in 2002 but has recovered since the election of Luiz Inácio Lula da Silva as president. Lula (as he is popularly know), a member of the labor party, was expected to make what was a bad situation in Brazil even worse. He has, however, been the main driver behind a Brazilian success story: After slowly building stability and credibility for more than seven years now, confidence in its policies is strong and a vast amount of natural resources put Brazil in a very competitive position for many years to come.

Both currencies will appreciate in the long-term. Due to currency controls, the only way people outside those countries can participate in their success is by investing in an NDF. An NDF or ‘non-deliverable forward contract’ is an instrument with a price agreed today for an exchange at a day in the future - a cash settlement (exchange of currencies) takes place upon maturity. Typically these NDF contracts are available for anything from 6 months up to three years.

Comments

[HaavBline:]

I agree the long term bullish cases for both Chinese RMB and Brazillian Real. But ‘non-deliverable forward contract’ seem like a rather complicated and cumbersome investment vehicle for lazy investor like me.

What about the ETFs? There are CNY and CYB for the RMB and BZF for the Real. WisdomTree has been running ads for CYB on CNBC recently.

Oct 13 01:54 PM

[Cashdollar:]

The ETFs use the same contracts. Also they have hardly any volume.

Oct 13 03:35 PM

[elliot_mllr:]

What about the tie between the Chines RMB and the USD? There is a very small difference between them introduced several years ago at the insistence of the US govt. which wanted th RMB to freely float, The Chinese resisted that but allowed for a very small difference between the two currencies on a floating basis (as I recall it was about 8%, but my recollection may be imperfect).

Oct 14 02:39 PM

[LCACM:]

The implication of the article is that China and Brazil seem to have very succesful economic models, and that Western Europe and US have economies that are slowly disintegrating. Is it time then to revisit our assumptions as to the types of political and economic structures that produce the most prosperity?

Oct 16 09:34 PM