Time to Expect Big Yuan Returns?

| About: WisdomTree Chinese (CYB)
This article is now exclusive for PRO subscribers.

Last week, China announced that it would allow its currency to float. Analysts and investors were anticipating the news for quite some time, as evidenced by the dramatic inflow of cash to WisdomTree’s yuan exchange traded fund. But the yuan may not rise as much as people think.

The Economist reports that China decided to increase the flexibility of its currency. But the announcement was a bit vague, as it also pledged to keep the RMB exchange rate “stable at an adaptive and equilibrium level.” China also noted that its current account surplus narrowed from 11% of GDP in 2007 to 6.1% last year. This was used to point out that there is no justification for a large-scale yuan appreciation.

Tao Wang of UBS thinks that by the end of 2011, the exchange rate will be 6.2 yuan per dollar, compared to 6.83 now.

According to John Jannarone of The Wall Street Journal, the WisdomTree Dreyfus Chinese Yuan Fund (NYSEARCA:CYB) grew assets from $102 million to $760 million over the past year end May.

Despite widespread speculation that the Chinese government would allow its currency to rise and the dramatic inflows into CYB, investors have seen little reward thus far. Give it time, though; after all, the ETF is up 0.6% in the last week.

Does that signal an uptrend? Not necessarily.

Jannarone is not optimistic about future returns. He reports that CYB’s manager “paid a premium above the spot rate because the market already had priced in currency appreciation down the line.”

Jannarone thinks that in order for CYB to profit, the market will have to underestimate the pace of the yuan’s appreciation. But, as Wang pointed out, the likelihood of a large price appreciation does not seem likely, especially given China’s resistance in revaluing its currency in the first place.

Sumin Kim contributed to this article.