Friday, September 17, 2010

"Commodity prices stand to benefit from yuan revaluation"

From Mineweb:
Yuan revaluation may be a political hornets next but there are some that believe it would be positive both for gold and for more productive commodities in the long run

The debate around the revaluation of the Chinese Yuan; the time it is taking and its impact on China's trading partners stepped up a notch, yesterday when US Treasury Secretary, Timothy Geithner, took his sharpest tone to date.

Stating among other things, "The pace of appreciation has been to slow. The undervalued renminbi helps China's export sector. It encourages out-sourcing of production and jobs from the United States. By continuing a rigid exchange rate, China is impeding the adjustments needed to secure sustainable global growth."

The comments drew fire from China, with Reuters reporting China's Foreign ministry saying "Pressure over the yuan exchange rate "not only would fail to solve the problems; on the contrary, it could have the opposite effect."
And, while much of the focus has been on the political reaction to the flashpoint and, the implications for currency markets as many countries break ranks "in a `beggar-thy-neighbour' use of '1930s-style devaluation, to borrow a phrase from The Telegraph's Ambrose Evans-Pritchard, a number of analysts are focusing on the implications such a move will have on commodities prices.

In an analysis of the dilemma facing Chinese officials, who have been encouraging their citizens to buy gold, Julian Philips asks, "How will investors feel if the Yuan were to rise 20% - 40% against the Dollar while gold falls by the same amount inside China?

He says, " The U.S. says that it [the value of the Yuan] should rise 40% to level the playing fields. A straight translation of such a rise will mean a fall in the Yuan price of gold of:
                                Yuan 6.7597 x Gold price $1,250 = Yuan 8,449.63
                                Yuan 4.0558 x Gold Price $1,250 = Yuan 5,069.75
That is a huge drop in the value of their savings. Big enough for even the most tranquil of investors to have a major sense of humor failure."

That assumes of course that the price of gold remains flat rather than rising in dollar terms along with the Yuan. And, if China is concerned about the loss of value of its citizenry's savings, it could begin to actively and openly purchase gold which would in all likelihood see the price of gold rise.
All that said, there are countervailing arguments to be made in favour of revaluation, especially as signs are emerging of a rise in inflation in the country - China could use the revaluation of its currency to blunt the effect of imported inflation.

And, if one assumes that, while it may not be as quick as the US would like, the Yuan will eventually revalue, the next question becomes what would the longer term impact be for commodity prices.
In a note put out earlier this week, Natixis writes, In anticipation of a revaluation against the dollar, Chinese holders of dollars have an incentive to diversify into assets that are more likely to hold their value.
"Alongside other major currencies (SAFE holds euros, sterling and yen) assets such as gold provide an alternative store of value. Although China has increased significantly its official holdings of gold in recent years, this still remains small (little more than 1%) in relation to total FX reserves."

Natixis goes on to say that the decisions facing Chinese households are equally difficult, "With the money supply growing at almost 20%, where should prudent Chinese savers put their money? Bank accounts or bonds denominated in CNY generally pay a negative interest rate. Both equity markets and especially real estate remain under pressure from official policies to constrain "speculation."

Investment in overseas currencies or markets is difficult. As a result, precious metals are inevitably benefiting from this situation of restricted choice, with gold, silver and platinum all experiencing substantial Chinese inflows over the last 12-18 months. "

As mentioned earlier there are some problems attached to this increase in Yuan denominated gold but, Natixis points out that an appreciating currency will provide Chinese households with more international buying power.

"There will also be a clear incentive for Chinese companies (if not government too) to increase purchases of raw materials, both as their purchasing power in dollar terms increases, and perhaps also as a way of moderating the size of reported trade surpluses in the face of international pressure. China has been constructing storage facilities for Phase II of their strategic oil reserve, which could easily be put to use, while other scarce commodities such as copper could sensibly be stockpiled too."...MORE