Inventive investors shelter behind hedges
To investors and speculators around the world, the yuan is that most treasured of trades: a one-way bet. Many are convinced the currency is deeply undervalued, and that it is bound to appreciate significantly over the next 12 months.
For Chinese companies and rich individuals, the solution is straightforward. They are busy converting the holdings of foreign exchange they have built up in recent years, sometimes legally but frequently illegally.
Just how much of this 'hot money' is flowing into China is hard to assess, but last year, the 'errors and omissions' section of China's balance of payments showed an inflow of US$27 billion. Much of this will have been illicitly-held foreign exchange, repatriated and invested into China's frothy property markets.
Foreign speculators wanting to take a position on the yuan have had to be more inventive. One route is trade in the offshore market in non-deliverable forward contracts on the yuan-dollar exchange rate. These are dollar-settled derivative contracts which allow speculators or hedgers to take positions on the future exchange rate.
Trading interest runs high, and at the moment the price of the one-year contract is implying the market expects a 6 per cent appreciation in the yuan over the next 12 months.
Investors have also taken big positions in the currencies and assets of the mainland's neighbours as proxies for the yuan, anticipating price rises should Beijing revalue. The most obvious choice is Hong Kong, where both the local dollar and the stocks of firms with exposure to the mainland have attracted buying from foreigners in recent months.
Speculative investors have also targeted other regional markets as a play on yuan revaluation, buying the South Korean won, the Taiwan dollar and the Thai baht. Increasingly they are also buying assets in Malaysia, or betting in the offshore non-deliverable forward market that the ringgit, which has been pegged at M$3.80 to the US dollar since 1998, will be revalued if China adjusts its exchange rate.