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Why You Should be Worried About China's Currency...

Street Authority

Street Authority

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Signs have emerged in the past two weeks that China is paving the way for its currency to start appreciating. It may take a year or two to see even a 10% or 20% rise, and practically nobody else is writing about this at all (which surprises me), but this will mean big ramifications for investors.

Under steady pressure from the United States, Chinese policy planners have generally shrugged at the prospect of letting its currency appreciate. In recent months, other trading partners in Asia, along with emerging powerhouses such as Brazil have also chafed at a currency policy that has been seen to help China and hurt the rest of the world. Although the rising pressure has certainly been noted in Beijing, Chinese planners have long sought to let their currency appreciate when they're good and ready.

That time finally seems to be at hand.

Laying the groundwork

China's currency has actually begun to modestly appreciate in recent months. Six months ago, 10 yuan were worth about $1.46. That figure has steadily risen to a recent $1.52, though many economists think that if the yuan actually freely-floated on world currency markets, 10 yuan it would be closer to being worth $2.

Yet a number of steps need to be taken before the yuan is truly unfettered. For starters, businesses need to be able to ink deals in yuan outside of China's borders. That step was taken for Hong Kong a few months ago, and just this week, a group of China-based companies got the green light to enter into yuan-denominated contracts elsewhere in the world. It's only a small scale effort, but it's a start.

More intriguingly, the state-owned Bank of China has authorized foreign branches to start buying and selling yuan. That's a tricky move, because if foreigners start to speculate on an eventual steeper rise in the yuan, then many will seek to sell dollars and buy yuan. Right now, it's a bit hard to gauge the actual value of the yuan in a freely-floating currency world, but as noted above, the yuan is likely undervalued by at least 20%.

The lessons from other central banks that try to artificially depress the value of their currency need to be heeded. In places like Venezuela, locals and foreigners alike sell dollars in the black market, as they can do much better than the bank-sponsored rate. As China takes further steps to open up the yuan, pressure builds to make even more aggressive moves, lest a black market emerge.

Will all this play out in 2011? Probably not, but China's "beggar thy neighbor" currency policy does look set to end within the next few years. In the mean-time, the yuan may be allowed to appreciate further against the dollar, perhaps up to the $1.60 per 10 yuan rate.

Looking over the horizon

So if we are on a path that gets the yuan to strengthen -- perhaps by 20% to 25% from current levels -- you need to start thinking about your investment moves now. Here are just a few examples of the investment implications:

  • A fast-rising consumer class has taken to luxury goods, as was the case when Japan became affluent in the 1980s. American and French brands have huge cachet with the managerial and executive class in China. A recent report from the Boston Consulting Group predicted that Chinese spending on luxury goods would surpass the United States some time this decade. Tiffany (TIF) is already marking 20% annual sales gains in China. Other branded firms such as Nike (NKE) have been building a Chinese presence for the last decade and are now counting on that market for the bulk of future sales growth. And as I noted earlier this week, GM (GM) thinks that China will be a big part of its sales mix in coming years. [Read why Morgan Stanley thinks GM could jump 150%]

  • A rise in the yuan is bad news for many electronics manufacturers that rely on Chinese plants for a steadily rising share of their output. Virtually no major tech firm is immune, from Apple (AAPL) to Hewlett-Packard (HPQ). Those firms will need to seek out even cheaper countries such as Vietnam, or will have to raise prices to preserve margins. Mexico could be a clear beneficiary as multinationals with plans in multiple countries shift production back closer to home.

  • Chinese tourism also looks set to move to a higher plane. Until now, many Chinese consumers have begun to venture out around their own country or to Asian neighbors. But with an increase in spending power, they'll increasingly look to travel to Europe and the United States. That should be a real boon to the global lodging and entertainment stocks such as Marriot International (MAR), Starwood Hotels (HOT) and Walt Disney (DIS). (If you have kids who want to work in the hospitality industry, have them start learning Chinese now).

  • Chinese stocks would hold more appeal to U.S. investors simply because a move in the currency impacts a stock or fund by a commensurate amount. For example, the PowerShares Golden Dragon Halter USX China Fund (PGJ), which invests in companies in mainland China, would rise 20% if the yuan appreciates 20%, all other things being equal.


Action to Take --> You should pay attention to what's coming out of Beijing these days, because its currency moves will likely affect your portfolio in one way or another.

A rising Chinese consumer class should stimulate demand for certain U.S. imports, and highly-automated industries will become more competitive vis-a-vis their Chinese rivals. We may even see more Chinese companies acquire U.S.-based firms, which in itself may yield job creation. The areas above are just some of the ways your portfolio could be affected. But a correct reading of the tea leaves could protect you just as well as help you profit.

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-- David Sterman


About the author:

Street Authority
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 2.5/5 (2 votes)

Comments

johnexo12
Johnexo12 - 3 years ago
To make money on currency trading you need to work in large volumes. Often the margin of profit is 1%. Companies that do this need large reserves.

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