Recent market volatility in all sectors has made it difficult to find long-term opportunities that offer value. From a currency perspective, there are few places to park your capital.
In early September the Swiss National Bank pegged the Swiss franc to the euro, stopping the most reliable bull currency trend in its tracks. It seems odd these days to want to be pegged to the euro, but currency appreciation holds its own hazards, and efforts by the Swiss to throw cold water on the franc rally have failed.
Fiat-backed currencies are being rejected. The Eurozone is in trouble, burdened by sovereign debt problems that won’t go away; the U.S. dollar is suppressed by near-zero interest rates, and the Federal Reserve has pledged to keep interest rates exceptionally low (basically zero) through mid-2013.
Commodity-based currencies, the strongest currencies over recent years, are beginning to feel the pain of a global demand retreat — the Australian dollar and Canadian dollar had strong runs, but now appear vulnerable.
This situation confronts the trader with the question: Are there any attractive currencies left?
Yes, there is one — the Chinese yuan.
Economists consider the Chinese currency to be undervalued by as much as 20%. That’s because it’s not a free-floating currency — Chinese policymakers tightly control its exchange rate. They allow it to trade in a tight band against the U.S. dollar, which has remained at a stable 0.5% in either direction. The policymakers keep a tight rein on the currency to keep the country’s export costs low, but the downside to the artificially low exchange rate has been inflation. To combat it, the Chinese have been boosting the yuan’s value slowly. It has risen 7% against the U.S. dollar since mid-2010 (see "Almost free").
In the context of global rejection of fiat currencies, such a slow appreciation is a welcome sign of stability. Yes, there could be dips, particularly if there are pauses in China’s growth, but over the long-term the yuan appears more stable than most currencies, including the dollar, because China is not burdened with the debt load of the West.
Martin Feldstein, Harvard economics professor and National Bureau for Economic Research president emeritus, noted in a recent article that the yuan (renminbi) is likely to rise. "The Chinese government has been reassuring its domestic manufacturers that it will not let the renminbi jump sharply as some foreigners have advocated. But it also has made it clear that the renminbi will continue to rise and it has advocated that its manufacturers shift production to products for the domestic market," Feldstein wrote. "The increased domestic spending in China will increase demand and raise inflationary pressures in two ways: ... A stronger renminbi will reduce the demand for those products and therefore limit that source of inflation [and] also reduces import costs, including the costs of raw materials that are used in Chinese production."
How can you participate in the Chinese yuan? One way is to buy into the Wisdom Tree Chinese Yuan exchange traded fund (CYB) or the soon to be listed (mid-October) CME Group yuan FX futures. The CYB is designed as an easy way to invest in changes in the yuan’s value. It has seen a steady appreciation over the past year, though with more volatility (see "A liquid alternative").
But that’s not the only attraction; this ETF also has an options-chain. This means traders can be more flexible and apply options-based risk management to their investment in the yuan. They can execute tactics like covered call combinations, collecting income by writing call options with higher strike prices.
While many experts believe the Chinese yuan will become the world’s reserve currency eventually, it doesn’t have to in order to appreciate. The bottom line is that in the current global currency chaos, the Chinese yuan looks stronger than most currencies and most likely will continue to get stronger.
Abe Cofnas is the author of "Sentiment Indicators" and the forthcoming "Binary Option Trading: Strategies and Tactics" (Bloomberg Press). He can be reached at email@example.com.