2 Ways to Trade the Yuan with ETFs

05/11/2011 7:00 am EST

Focus: FOREX

The Chinese government has been slowly strengthening the country’s currency, and have no plans to stop. These two funds are good places to start when looking for a way to capitalize.

One of the biggest stories in global finance over the past few months has been China—specifically, its leaders’ unwillingness to revalue their currency to what many Western nations see as an appropriate level.

Some analysts believe that the yuan is undervalued by as much as 40%, potentially giving the People’s Republic an unfair advantage in a host of industries, and allowing them to easily outbid most countries on price alone.

While a number of politicians have been—and are still clamoring for—a quicker revaluation of the yuan against the dollar, the Chinese government has been slowly but surely strengthening its currency under the radar of most investors.

Now, for the first time since 1993, the yuan is trading below the 6.50 per dollar mark. This marks seven straight weeks of gains for the currency, which is the longest continuous gain since before the financial crisis began in the fall of 2008.

Unsurprisingly to many, the move comes right before the country’s Vice Premier is expected to meet with US Treasury Secretary Timothy Geithner, helping to take some wind out of America’s sails in regards to calls for further appreciation of the yuan against the dollar.

The currency has already gained 1.5% so far this year against the greenback, and analysts anticipate that the total for the year will come to about 4.5%. This will move the exchange rate below 6.30 by the end of December.

While no one knows for sure what the regime in China will do next, some are speculating that a continued appreciation of the yuan may be in line for the country. This is because inflation is an ever-growing problem in the nation, and China has already hiked reserve-ratio requirements on a number of occasions, looking to curtail price increases through this mechanism.

However, slowing loan growth has not had the desired impact, and now many feel that Chinese officials will look to a stronger currency in order to stem the rising tide of increased prices.

“Inflation is still higher than what the government would like to see,” said David Cohen, a Singapore-based economist at Action Economics, who previously worked for the Federal Reserve. “The central bank is tolerating faster currency appreciation to contain import costs.”

If China follows through on this strategy, it could bring about a marginally higher yuan sooner than when most people originally thought.

China Yuan ETFs in Focus
Currently, there are two ETFs that track the Chinese yuan’s exchange rate against the US dollar, CNY and CYB.

Both of these products have been pretty much flat since their inceptions—but with continued commodity-price pressure and a reasonably fast increase in the pace of the yuan’s gains, investors could look for this to change in the near future if the Chinese government remains on this path.

Below, we highlight some of the key differences between these two funds:

NEXT: WisdomTree Dreyfus Chinese Yuan Fund

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WisdomTree Dreyfus Chinese Yuan Fund (CYB): This fund is by far the most popular product tracking the space, as the fund has close to $670 million in assets under management, while trading roughly 250,000 shares a day.

The exposure to the yuan is achieved by holding very short-term, investment grade instruments; the average days to maturity for the currency contracts is just 130 days, or a little over one third of a year.

Over the past year, CYB has gained 2.9%, and is up 0.8% in the last four weeks alone. While this may not sound like a lot, it represents a rather large move for the often-flat yuan.

Here is a recent daily chart:

chart
Click to Enlarge

Market Vectors Chinese Renminbi/USD ETN (CNY): Although this product is not nearly as popular as its WisdomTree counterpart, the fund does provide an interesting slice of exposure to the market by allowing investors to buy into an ETN. This ensures that there will be no tracking error between the fund and the index, but it does open up investors to some level of credit risk—in this case, to Morgan Stanley, which is currently rated A+ by S&P.

Over the past year, CNY has failed to keep pace with its counterpart in the field, gaining just 1.5%. However, it has managed to post similar gains over the short term, posting a 0.7% gain in the past four weeks.

Here is a recent daily chart:

chart
Click to Enlarge

Eric Dutram can be found at ETFdb.com.

By Eric Dutram

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