In the past few months several investors have showed an interest in investing in Chinese currency (NYSEARCA:RMB) to take advantage of an assumed appreciation in the currency that will happen in the future. Since buying and selling RMB is problematic many overseas investors have chosen to invest in Chinese equities as a proxy for the currency in pursuit of quick investment appreciation. There is a good reason to believe that this strategy may not work as planned.
Firstly, the Chinese government has not indicated that it will appreciate the currency in the future. All the noise about currency appreciation has been made outside of China. The Chinese government has typically made its policy intentions known in the past. Yet, today there is no comment made from Beijing indicating it intends to change the current fixed rate (of RMB) to the US Dollar.
Suppose, however, that later this year Beijing changes its mind and revalues the currency up 10%. How might this play out for investors in Chinese equities? Here is a possible scenario:
On the run up to the currency revaluation investors – and speculators – buy into Chinese equities driving up the price. The revaluation happens and within two days Chinese stocks have fallen 5% and are still headed lower. What happened?
What happened is a classic case of what traders refer to as “buying the rumor, and selling the fact.” A rumor of a potential trading opportunity starts. The first people to buy into it are astute traders (speculators) who wait for the rest of the public to catch wind of the rumor. Equity prices move up. The good news is finally announced. Speculators liquidate (if they haven’t already) their holdings immediately. Other investors who waited for their reward start to sell. As the price weakens other investors who waited, sell to avoid making a loss. Speculators see what is happening and now switch sides and begin to short sell stocks adding to the selling pressure.
From the point of view of a potential investor there maybe little enticement to buy Chinese equities after a RMB revaluation upwards. Most companies in China are dependent on exports and a currency revaluation makes them less competitive and less profitable. The only other possible proxy for a currency revaluation is buying industrial commodities like copper (China is the worlds single largest consumer of copper) which has already seen huge price appreciation in the last 12 months. All commodities are priced in USD and if the RMB were revaluated 10% upwards then Chinese consumers would see a 10% discount in prices. If Chinese companies are letting inventories drop in anticipation of buying cheaper after an assumed currency revaluation (there is no proof of this by the way) then industrial commodities have the best chance of gaining.
There are good reasons to invest in Chinese equities for the long term: China is growing (9.5% forecast for 2010), and domestic salaries, and consumption are rising. We are at the beginning of a business cycle that should continue. These are all solid fundamental reasons to invest. A currency revaluation is a one time event with little more than a temporary affect – and that affect could turn out to be a negative one if it happens at all.
Disclosure: No Position