Warning: Buy China Yuan ETFs (CYB, CNY) At Your Own Risk

by on February 26, 2010 | ETFs Mentioned:

As job loses continue to mount in the United States–first-time claims for unemployment insurance recently rose by 22,000 to a seasonally adjusted 496,000–many political officials and ordinary citizens are looking for creative ways to stem the seemingly never-ending loss of jobs. One of the hottest issues in recent weeks has been China’s currency policy, which many feel has been grossly manipulated to give the country a significant advantage in the global economy. Some argue that the yuan is undervalued by as much as 40%, an advantage that makes it virtually impossible for American manufacturers to compete with cheap Chinese exports.

YuanAs a remedy to this practice, the Obama administration has threatened (and implemented) several tariffs on a variety of Chinese imports. Moreover, Obama has made an effort to hold his ground against an increasingly important economic superpower, approving arms sales to Taiwan and meeting with the Dalai Lama, drawing Beijing’s ire and raising the possibility of a trade war with China. As Obama has ratcheted up the pressure over a variety of issues, Congress has now joined the yuan / dollar debate as well. Earlier this week, 15 Senators sent a letter to Commerce Secretary Gary Locke criticizing him for failing to look into allegations that China is manipulating its currency and thereby unfairly subsidizing its export industries. While all of this political posturing may look good for constituents, it has done little to influence the policies of the rising Asian superpower.

China, as the second largest holder of U.S. Treasury bills, currently possessing $755 billion of the bonds, holds significant sway over the U.S. economy and it seems unlikely that policies will be changing anytime soon. Recently, China sold $34 billion in U.S. government bonds and has shown a preference for hard currency over the greenback in its reserve holdings, which many see as a signal that Beijing has lost confidence in American economic policy and may intend to forge its own path. “The yuan’s exchange rate is not the main reason triggering China’s trade surplus, America’s trade deficit or global economic imbalances,” said Yao Jian in a New York Times article on Thursday. “Many exporters are still struggling for survival, so I think a stable exchange rate for the yuan will remain a prime target of China’s current economic policies.”

Despite tough stances from Washington, China has little incentive to let its currency float. In recent weeks, speculation over China’s plans to wind down stimulus plans has swayed global equity markets, highlighting the prominent role that China now holds on the global stage. China has the upper hand in Sino-American relations, a position it will likely retain for the foreseeable future.

Yuan ETFs: Steady As She Goes

Given China’s stance its currency, it’s not surprising that yuan ETFs have seen little movement over the last year. The Market Vectors Chinese Renminbi/USD ETN (CNY) has gained 0.1%, while the WisdomTree Dreyfus Chinese Yuan Fund (CYB) is up about 0.2%. Despite the flat line returns, investing in the Chinese yuan through ETFs has become very popular. CYB now has assets of $550 million (up from $440 million at the end of last month, according to the NSX), and has seen trading volumes as high as 1.5 million shares daily over the last week.

It appears as if investors are betting big bucks on a yuan revaluation this year. But, as detailed above, such a move from Beijing is far from a done deal, particularly if China’s trade surplus continues to narrow, as officials anticipate it will. “If China experiences, or even expects, an overall trade deficit in the relatively near future with its current yuan-dollar rate, then arguments about the yuan being unfairly valued will no longer carry much weight” writes Vincent Fernando. “Regardless of whether or not they are true.”

Even if China does ultimately relent, revaluation would be a very gradual process according to the China People’s Political Consultative Conference, an advisory body to Chinese parliament. Any revaluation is unlikely to exceed 5% this year, consistent with previous eases of the dollar-yuan relationship.



The real upside to these funds is their near-zero correlation to most assets, making them a potentially valuable diversifier. Plus, since it is extremely unlikely that the yuan will lose ground against the dollar–a downward revaluation would spark major outrage from world leaders–the downside to these funds is limited.

For investors looking to preserve capital, add non-correlated assets, and smooth overall portfolio volatility, CYB is a great option. But those hoping to generate absolute returns or current income will likely be disappointed.

To read more on the topic, see our Guide to China Yuan ETFs. For more ETF ideas, make sure to sign up for our free ETF newsletter.

Disclosure: No positions at time of writing