Time To Jump On The Band Wagon And Put On Some Asia Trades

by: Gino Bruno D'Alessio


Various players setting up this type of trade.

Overall weakness in China which may spread throughout Pacific Rim.

Trades to implement in currencies and rates.

Various Hedge Funds Shorting China

It probably all started with George Soros's comments during the World Economic Forum meeting in Davos, Switzerland. Where he said a hard landing for the Chinese economy was inevitable and he was, therefore, betting against Asian currencies as a result. Since then, reports are surfacing of various Hedge Funds taking on the powerful Chinese government in plays against its stocks and currency. Kyle Bass's Hayman Capital sold most of its other investments to concentrate its exposure to China. It is 85% invested in shorting Asian currencies, including the Yuan and Hong Kong Dollar. They are playing a long term bet with a return horizon stretching 3 years.

Greenlight Capital Inc. has options on the Yuan heading south and billionaire trader Stanley Druckenmiller and hedge fund manager David Tepper also have short positions against the Renminbi. Other Hedge funds mentioned by the WSJ as being short include the Carlye Group, Scoggin Capital, and ESG Short China Fund. This is happening at a time when the Chinese government is showing concerns for a Soft landing and taking on this government could prove risky as it has the largest foreign reserve holding worldwide at $3.9 trillion.

The situation in China

The markets at home have not had a great start to the year and economic data has not been as strong as forecast previously. Latest NFP figures came out much lower than expected and attention has been focusing on China being the catalyst as fear of a global recession begins to build.

The economic slowdown in China has been gaining speed, the last two GDP growth figures were both lower than previous at 6.9% and 6.8%. The PMI index for manufacturing is currently at 48.4 and has been below 50 since July last year. Levels below 50 indicate a contracting economy. But the biggest concern for investors is that the contraction may be larger than the government controlled statistics office is actually reporting.

The Chinese currency was selected by the IMF as a Reserve currency last November 30th; this was due mainly to its widespread use in international trade. The effect of the Yuan joining the select club of reserve currencies still remains to be seen but initially, it has had little impact.

Capital outflows for the last quarter were down by $843 billion HML, although the average capital flow from 1998 to 2015 has been a negative $325.54 billion HML, we are still considerably low and capital flows have not been more negative since 2008.

Last January 12th, there was a run on Yuan short trades in Honk Kong forcing the overnight lending rate, to finance short positions, up to 66% nearly 10 times the normal rate, which fell back down to 8% the next day. Despite the firepower of the Chinese government, there are still limits to what it can do and for how long it can sustain any intervention.

How to play the market

It's not easy to short sell Chinese stocks; foreign investment in Chinese A shares is not even permitted. However, you can gain exposure to Chinese equity through a number of ETFs. Each ETF tends to focus on different segments of shares. SPDR S&P 500 (NYSEARCA:GXC) is the most comprehensive, but iShares China Large-Cap (NYSEARCA:FXI) is the largest and most traded fund, with $4.65 billion AUM. The Yuan is fairly accessible through most online brokers and so is the Hong Kong Dollar. If futures are the preferred vehicle, then the CME also quotes USD/CNH futures. Contract size like the other FX futures is $100,000 which may be large but margins are low at CNH 15,000 for front contracts and CNH 16,100 for back-end contracts. Futures allow you to hedge your Long contract by selling another contract month. For choice, I would prefer being long the back-end and short the front. As my view is that long-term Asian currencies will depreciate but short term, they may bounce back up.

If your online broker has access to the Honk Kong exchange (HKEx) then you could still gain exposure to the Chinese stock market with the use of futures. The exchange offers various indices; my choice would be for the Hang Seng Index Futures HSI, tick value is HK$50. Or MHI, the mini Hang Seng Index which has a tick value of HK$10. If you really want to gain exposure to the mainland and corporations operating there, then you should go for the CES China 120 Index.

If the slowdown in the economy continues, then the Chinese government will also probably lower interest rates in an attempt to spur the economy. The government has already cut interest rates 5 times since the beginning of 2015. The Hong Kong exchange quotes 3-month HIBOR HB3 and 1 month HIBOR HB1. For choice, I would prefer buying the 3-month contract as it should feel any interest rate cut in a greater way. The notional size of this contract is HK$5,000,000 and one tick equals HK$125.00, initial margin is HK$1,820.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: How does that look now? Thanks.

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