Aug 12, 2015
Despite what the markets seem to think and many news sources
would have you believe, China’s move to devalue the yuan by 1.9% is not an act of desperation intended to prop up a failing economy. It’s not a surprise. And, it sure as heck is not the end of the financial universe as we know it.Instead, it’s a brilliant move that singlehandedly changes the investing landscape and creates a fabulous new set of profits if you’ve got the guts and the smarts to make your move.
Today we’re going to talk about why and, more importantly, what makes the situation so very appealing and so potentially profitable at the same time.
As always, I’ve got a few specific recommendations to get you started.
Let’s begin by talking about what Beijing did and why I believe this is a major move that changes the investing landscape.
This is the biggest currency adjustment Beijing’s made in 20 years and it’s the biggest single drop since 1994 when China ended the old dual currency system.
On the surface, the 1.9% decrease in that nation’s central bank “reference rate” is designed to support exporters and boost market pricing in China. Western analysts view it as a threat because it’s clearly more “price fixing” on China’s behalf.
What they don’t understand is that China’s been propping up the yuan for years to guard against capital outflows, to protect foreign currency borrowers and to stabilize the yuan’s role in global trade as a potential reserve currency for the International Monetary Fund. If you think China’s got too much power now, imagine what the world would have looked like today if that nation had not restrained its currency.
Dropping the yuan is actually a means of making room for market-based pricing.
I’ve long counselled that Washington had better be careful what it wished for when it accused China of currency manipulation, specifically because of the kind of reaction that’s happening today.
Contrary to what Washington would have you believe about China’s currency being undervalued, the yuan’s real effective exchange rate has risen by 33% over the past four quarters, according to the Bank of International Settlements. In fact, the growth was so high and so fast that it was the single fastest appreciation move and the highest among 32 major global currencies tracked as reported by Bloomberg.
Dropping the yuan is not only logical, but part of the path China has to take to make its currency fully convertible.
In the old days, China would simply set a peg rate to the dollar that – love it or hate it – was completely arbitrary. Hence the currency manipulation allegations.
But now – effective immediately – market makers who submit prices to the People’s Bank of China as part of the reference rate have to take the prior day’s closing spot exchange rate into consideration, foreign exchange supply and demand, AND changes in major currency rates. In other words, market-based pricing.
This is exactly what’s required by the IMF for reserve status – that a currency be freely usable and market driven.
China’s Attack on the Greenback
The other thing that stands out about this move is that China is doing Yellen’s job. You’re not hearing about that… yet. But you will.Classic economic theory dictates that a stronger dollar makes U.S. exports weaken, imports cheapen, devalues overseas profits, and brings about a sharp increase in domestic labor cost. By any measure, it’s a restrictive economic policy which is why the Fed has so far refused to raise rates and – with a straight face – been able to sell their zero interest rate policies for so long.
The problem is that sooner or later the markets always fix things themselves.
China’s move immediately makes the dollar stronger. That, in turn, further hamstrings U.S. exporters and worsens the trade imbalance with China. It also shifts the competitive advantage to Beijing.
Theoretically, Team Yellen would have addressed this by shifting the advantage to the United States with a rate increase long ago. Instead, what we got was more of the same – a totally inept sequence of fiscal blunders, stimulus and a “data-driven” Fed that’s scared of its own shadow.
China simply took matters into its own hands.
Washington and New York claim they didn’t see this coming and the headlines suggest it was out of the blue. Not true. In fact, China’s telegraphed this move for years.
For example, Yi Gang, a deputy governor at the People’s Bank of China noted on November 20, 2013, that “it’s no longer in China’s favor to accumulate foreign-exchange reserves.” Zhou Xiaochuan, who was the leader of China’s central bank at the time, proposed “supersovereign currency” that would diminish the importance of any national currency but especially the U.S. dollar in March 2008.
My point is that while Washington views the dollar as a weapon, China increasingly views it as a liability. And, in accordance with that nation’s view of the world, Beijing has simply taken steps to defend itself because our leaders couldn’t or wouldn’t.
So now what?
We’ve actually seen this playbook before, albeit in a different era with different actors. Think back to September 1931, when the United Kingdom stunned the world by eschewing the gold standard – and in the process, caused the pound sterling to plummet more than 30%.
The severe devaluation gave Britain an exporting advantage – until a “me too” effect led other major exporters to take a hatchet to their own currencies. Of course, there’s no gold standard to abandon today, which is a major reason the media have such a hard time envisioning another currency war, even as it happens right in front of them.
This time around, Beijing’s actions firmly shift the global economic balance in China’s favor. Sadly, Western Central Bankers and politicians could have prevented this situation, but that’s a story for another time.
What matters now is how you handle the situation and how to position your money for profits even as most investors will be left behind their own self-imposed “Great Wall.”
Three Plays to Make in the Opening Salvo of China’s Currency War
First, China’s move begs you to “buy” dollars.The dollar has rallied against all major peers by 20% over the past 3 quarters according to the Bloomberg Dollar Spot Index and this adds fuel to the fire. That’s because the global growth story is all about the Fed, not trade. Remember, it’s the best looking horse in the proverbial glue factory; incidentally, I think China’s move just put Yellen’s rate hike on hold so the party continues.
The easiest way to play this is to buy the PowerShares DB U.S. Dollar Index Bullish Fund (UUP). It’s worth noting that if you already have U.S. based companies in your portfolio, you’ve got this base covered indirectly. So this ETF is really gravy or a complimentary trade to your core holdings.
Second, Apple Inc. (NasdaqGS:AAPL)’s suppliers just got a Christmas bonus.
Apple’s got hundreds of suppliers, but Hon Hai Precision Industry Co. Ltd (2317.TW) catches my attention. It’s part of the Foxconn Technology Group and has more than 1 million workers assembling iPhones, iPads, and other products including PCs, TVs, and gaming consoles.
You’ll have to do a little work to buy it, though, because it’s on the Taiwan exchange. Still, don’t let that deter you. The PE is a low 9.15, according to YahooFinance, and China’s yuan instantly provides a kick to margins that will be related to the upcoming holiday season. Most investors can’t think that far ahead, so they’ll be left far behind if I’m right.
Third, the commodity rebound will have to wait.
Oil, like many other commodities, is priced in dollars. That means it’s going to get cheaper as the dollar gets stronger, barring some sort of catastrophic supplier interruption. That’s important because global growth and global demand continue to increase. Many people are forgetting the linkage, which is why the best oil companies are now priced as if they’re going to go out of business.
One my favorites is a choice that we’ve talked about many times, the Williams Co. Inc. (NYSE:WMB). The dividend is a healthy 4.70% and it’s got billions in capital investment projects coming online, the value of which is not yet reflected in the stock price.
There’s going to be a lot of discussion in the days to come about what this move really means for markets. Most of it, sadly, will be tremendously uninformed and wrong. So don’t “buy” it.
Instead, concentrate on what you now know about the situation and why there are huge profits to be made.
Chinese bears have only been one thing consistently for 40 years… wrong.
Until next time,
Keith Fitz-Gerald
