Let China Put Money in Your Pocket

11/17/2009 9:57 am EST

Focus: MARKETS

Jim Jubak

Founder and Editor, JubakPicks.com

When China relaxes the peg that ties its currency to the US dollar, a lot of pent-up appreciation is going to be unleashed. If you're an investor, now's the time to make your move.

From the perspective of the global economy, there's a whole lot that's wrong with China's refusal to let its currency appreciate against the US dollar:

  • It's killing the exports of China's Asian competitors, who are seeing their won and yen appreciate against a renminbi that's falling in price along with the dollar


  • It's delaying any real rebalancing of the huge trade deficit between the US and China


  • And it's feeding into soaring asset prices, bad loans, and runaway investment in unnecessary manufacturing capacity in China

But if you're an individual investor looking to put money to work, the dollar-renminbi peg is a gift. And you'd better put it to work for you now, because it won't be here forever. (For my take on how long the peg will last, see this recent post.)

As a humble investor looking for someplace to put some cash, the world's emerging markets are likely to appeal to you. These economies look set to grow faster than those of the United States, Europe, and Japan for a decade or more, but emerging market stocks have had a huge run. Forget getting in through the back door either: The commodity-dominated markets of countries such as Australia and Canada have run away from you, too.

Are you ready for the final straw? The currencies of many of these countries are much stronger against the dollar than they were at the beginning of 2009. Not only are emerging market and commodity-economy stocks more expensive in their own currencies than they were when this rally started March 9, but they are super duper expensive to any investor who needs to buy them with US dollars.

Other Currencies Climb Against Dollar

The Indonesian rupiah is 17% more expensive against the US dollar than it was at the beginning of 2009. The Brazilian real is up 35% against the dollar in 2009. And the Australian dollar is inching toward parity with the US dollar. It's up about 33% in the past 12 months.

Not the Chinese renminbi, though. In July 2008, when China re-pegged its currency to the dollar, it traded at 6.8 to 6.85 renminbi to the dollar. Today it trades at…6.8 to 6.85 renminbi to the dollar.

I won't pretend that Chinese stocks are cheap now. The iShares FTSE/Xinhua China 25 (FXI) exchange traded fund, or ETF, is up 88.5% since March 9. That's significantly more than the stunning 60.6% gain on the Standard & Poor's 500 Index ($INX) in that period. But it's less than the 122.7% appreciation—in dollar terms—in the iShares MSCI Brazil Index (NYSE: EWZ) ETF.

Most of the difference in the gains in the China ETF and the Brazil ETF—from the perspective of a US investor tracking the world in dollars—is due to the 35% appreciation in 2009 of the Brazilian real against the dollar versus the 0% appreciation of the renminbi against the dollar.

Think about that for a moment. First, it means that US investors just putting money into the Chinese market don't have to pay the penalty for 2009's incredible sinking dollar. Second, it means that these investors actually have the future appreciation of the renminbi to look forward to.

Spring-Loaded Currency

No one should expect the Chinese government and the People's Bank of China to go all Milton Friedman on us and let the renminbi soar against the dollar when they relax the peg. But it is fair to say that because of the peg, the renminbi has a lot of future appreciation against the dollar curled up inside it like a tightly compressed spring. I wouldn't be surprised to find that three years after China relaxes the peg, the renminbi has gained 20% against the dollar. That's how much the renminbi gained against the dollar in the three years before the peg was put back in place in July 2008.

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Right now, the futures market is pricing in 3% appreciation in the renminbi against the dollar in the next 12 months. Not much, perhaps. But I'll put my money into a market where the trend, even a 3% trend, is running in my favor any day.

But you can't take advantage of this trend if you don't play.

Here are five ways that you could make the current dollar-renminbi peg your friend and put the future appreciation of the Chinese currency to work for you:

  • You could buy an actively managed mutual fund. I personally own shares in Matthews China (MCHFX). Matthews funds have a long history of kicking the tires in Asia, and there's good value to an investor in paying the 1.23% expense ratio to get that expertise. Here's the company's Web site.


  • You could buy an ETF. I'd suggest the iShares FTSE/Xinhua China 25 (NYSE: FXI). With one buy, you get exposure to the big boys of China's economy, including China Mobile, China Life, and PetroChina.


  • You could buy a big hunk of the growing market for consumer financial products by buying shares of China Life (NYSE: LFC). The company has about 50% of the still very young insurance market in China. But as China gets wealthier and older—by 2050, a higher percentage of China's population will be 60 or older than in the United States—more people will look to consumer financial products such as life insurance to provide for old age and to provide security to the next generation.


  • You could buy into the continued emergence of a consumer economy in China by buying shares of Ctrip.com (Nasdaq: CTRP), the largest online travel company in China. On November 11, the company reported an 80% increase in third quarter profits on a 41% jump in hotel reservations and a 45% gain in flight bookings.


  • And, for the moment at least, you could buy into China's huge need for water and water infrastructure by buying shares of Duoyuan Global Water (NYSE: DGW), a supplier of water treatment equipment. On November 9, the company reported that third quarter revenue had climbed 31% from the third quarter of 2008, gross margins had climbed to 49.5% from 46.8%, and operating income was up 31.1%. The company divides its business into three product lines: wastewater treatment equipment, circulating water treatment, and water purification equipment.

You probably have other China stocks that you like. Just remember that to get the biggest bang out of the eventual end of the dollar-renminbi peg, you should look for Chinese companies that do the bulk of their business inside China in renminbi.

When do you want to buy these plays on the dollar-renminbi peg?

China is a volatile emerging market. The iShares FTSE/Xinhua China 25 ETF, for example, fell 10% from August 3 through August 31. Ideally, you'd like to buy into a drop like that.

And you'd like to avoid the kind of runaway enthusiasm that greeted Ctrip.com's recent earnings report. The stock climbed 7.4% on that earnings news November 12.

It's worth waiting a few days right now to see if the dollar strength that took most global stocks and commodities down on November 12 will last for a few days. It was a bounce in a dollar that had fallen too far, too fast that caused the 6% drop in the S&P 500 in late October into early November.

The peg isn't going to end tomorrow. You've got a few months to time your buying in this market.

At the time of publication, Jim Jubak owned shares of the following fund mentioned in this column: Matthews China.

More from Jim Jubak:
Potential Impact of Obama's Visit to China

Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com

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