The Link Between China, The Yuan and Commodities

Jun.21.10 | About: WisdomTree Chinese (CYB)

By David Berman

A lot of the immediate impact of China’s decision to allow its currency to float higher is being felt by commodities and commodity producers – as in, they’re going up.

Pierre Lapointe, global macro strategist at Brockhouse Cooper, noted that commodities are actually one of the reasons for China making the decision in the first place. Chinese consumer prices are above the target range, but producer prices look even worse: They have surged 7.1% over the past 12 months, mostly because of higher commodity prices.

The idea, then, is that a higher yuan will cool down the Chinese economy and perhaps put a brake on price increases because they will cost less in Chinese terms.

But it’s complicated. First off, most observers suggest that China isn’t about to let the yuan rise at a breakneck speed. As Mr. Lapointe noted, some observers believe the yuan is currently undervalued by as much as 40% – but China will likely allow an appreciation of something far less dramatic in the near term.

As for the ultimate impact on commodity prices, Mr. Lapointe sees only a slight impact. “This weekend's announcement aims at cooling down the economy. This will have a negative impact on marginal commodity demand. On the other hand, a stronger yuan will also lower commodity import prices to Chinese consumers (as most commodities are priced in U.S. dollars). The net impact of these the forces on commodity prices is still unknown. We estimate that the yuan appreciation will have a neutral to slightly positive marginal impact on commodity prices.”

So far, though, investors seem to like China's move. In late-morning trading, the Reuters/Jefferies CRB index of 19 commodities was up 1.2%. Crude oil was up 1.3%, copper was up 3.3% and natural gas was up 2.9%. However, nickel and aluminum were down 1.1% each.