May 9, 2011 / 8:50 PM / 8 years ago

Investors can still play China card

NEW YORK (Reuters) - Traders like to get into high-stakes games where there is a lot of volatility so they can win a quick pot and get out in a hurry.

A man smokes in front an electronic board showing stock information at a brokerage house in Shenyang, Liaoning province March 15, 2011. REUTERS/Stringer

Speculation is growing that China will again take some action to revalue as it meets this week with American trade officials at the U.S.-China Strategic and Economic Dialogue in Washington.

But traders betting on a quick rise might be disappointed.

Experts agree that even if China delivers a modest rise it will be a mere goodwill gesture. Instead they expect a brick-by-brick pace of growth in the currency — as exciting to watch as the Great Wall going up over thousands of years.

High-stakes market players and U.S. trade officials might not like that outcome.

For patient investors, however, it means there is still time to play the China card. Indeed, the slow appreciation of the Chinese currency could be a rare opportunity to find a relatively safe long-term bet in the otherwise volatile global economy,

“You have the currency at your back rather than in your face,” says Jeff Applegate, chief investment officer at Morgan Stanley Smith Barney.

It doesn’t mean go out and buy every Chinese stock available in the United States. But it does signal that the market patterns of the past decade could be reinforced. China’s gradual yuan rise will boost demand for commodities and those who produce them.

The strengthening yuan will could also bestow benefits to those who buy fixed income in credit markets favored by China. Increasingly that could include ‘dim-sum’ bonds floated in Asia by Western companies whose yields go up with the yuan.

CHINA EQUITY — THE DIRECT BET

Jake Dollarhide, the chief executive officer of Longbow Asset Management, suggests the slow and steady rise in the currency related to China’s organic growth will continue in the next 12 to 18 months. In the meantime he is taking long-range positions, holding iShares FTSE/Xinhua China 25 Index Fund. That fund is up 1.9 percent year to date.

“There is a really good chance that in two to three years, we could see the yuan’s appreciation take off at a fast clip with a large overall global economic expansion,” Dollarhide says.

Inflation remains a wild card for China — hitting a 32-month high of 5.4 percent in March and creating uncertainty for its economy. For investors, it makes the yuan even more of a one-way bet.

“Interest rate hikes and reserve requirement changes cannot tame China’s inflation problem,” says Joseph Trevisani, chief market analyst at FX Solutions in Saddle River, New Jersey. “The Chinese Government may have come to realize that they might as well have the inflation fighting help of a stronger yuan.

Trevisani expects the yuan to appreciate at the same steady pace it has taken in recent years, adding 4 percent by year end.

Longbow Asset Management’s Dollarhide says investors can consider a straight currency play like the WisdomTree Dreyfus Chinese yuan ETF, up 0.9 percent in 2011.

COMMODITIES PLAY

Key commodities have been on a long arc upward based on the falling dollar and the strengthening yuan. Gold and mining stocks were the leading sectors of the past decade.

How long can it go on? Japan’s yen traded at 350 yen to the dollar in the early 70’s. Its long rise carried it as high as 80 to the dollar in the decades that followed. The yuan has the same potential.

“It was 8.2 yuan to the dollar, now 6.8, and with further appreciation 6.2 to 6.3 later this year, said Jeff Applegate, chief investment officer at Morgan Stanley Smith Barney. “On a multi-year basis, pick a number. It (the dollar) will be way down.”

Based on the impact it will have on commodities, Dollarhide’s picks would be a straight bullion play by buying gold or buying the shares of gold and oil producers like Freeport McMoRan Copper & Gold, Exxon Mobil Corp and ConocoPhillips.

Dollarhide also suggests plays on other emerging market Asian nations that are expected to benefit from trade ties with China and a strengthening yuan such as Indonesia. He uses the Market Vectors Indonesia index.

In a recent sign of how this works, Chinese Premier Wen Jiabao promised Indonesia $19 billion of investment credit recently as he sought to build trust and end wariness between the world’s emerging power and one of the region’s brightest hopes.

“In the big picture it’s pretty clear to us, China (plays a) more and more importance role in the global economy and market,” says Yong Zhu, Wilmington, Delaware-based senior portfolio manager for emerging markets debt at DuPont Capital Management with assets under management of $303 million. “A lot of our investments have this theme.”

This means investing in economies throughout the region, Zhu says, citing potential in other Asian currencies like the Korean won and Indonesian rupiah.

FIXED INCOME — FOLLOWING CHINA’s LEAD

For fixed income-minded U.S. buyers, the currency and equity investments might not be attractive. And China offers little in the way of debt securities as a massive net creditor.

But Zhu says those who want yuan-powered yield should look to where China trades.

For example, China is a big buyer of soybeans from Argentina, The world’s No.3 soybean exporter. Because of this, Zhu says Argentina’s high-yield debt is attractive. A bond paying maturing in December 2033 yields around 11.847 percent.

On the same basis, given China’s demand for energy he likes the Venezuelan 7 percent maturing March 2038 which trades at USD$56.559 and yields 12.742 percent.

“We’ve been playing Chavez and Venezuela for 10 years,” says Zhu. “There is risk but but he’s been in power for 12 years and no default yet.”

DIM SUM BONDS — RAISING MONEY IN OTHER MARKETS

DuPont Capital Management’s Zhu suggests a big part of the future will be so-called “dim sum bonds” which cater to foreign direct investment in China from yuan-denominated bond issuance in Hong Kong and are open to investors outside China.

The takeout for investors is that as the yuan rises the personal return goes up when converting back to dollars. This adds to the yield itself, potentially significantly.

Both local issuers and western multinationals, such as McDonald’s Corp, which has a 3 percent yuan denominated bond maturing September 2013, are making increasing forays into that arena.

Consumer goods giant Unilever Plc became the first European company to tap the growing offshore yuan market by raising $46 million in March.

BE CAUTIOUS AS WELL AS PATIENT

There is a danger in putting too much stock in the yuan rise, of course. Optimism about China has pumped up some valuations to unrealistic levels. China stocks fell hard along with western markets in 2008.

“The yuan hasn’t really appreciated against very much this year apart from the U.S. dollar (and the Belarusian Ruble admittedly),” says Paul McNamara, London-based investment director at GAM Fixed Income, specializing in emerging market assets with $6.4 billion in assets.

Reporting by Nick Olivari Editing by Richard Satran

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