Saturday, October 31, 2015
At the bottom of the article it says that the volatility causes difficulty in doing business. So, how can Bit Coin become a real currency with it's volatility? Aivars Lode
Investors assumed China would keep the currency stable. They were wrong.
By Wei Gu And Anjani Trivedi
HONG KONG—When China’s government abruptly pressed the yuan lower last week, it upended Antonio Huang’s plan to quintuple a profit on a commodity deal.
Acting as the middleman on a US$3 million trade in the commodity coke, the former banker sought to sweeten his expected gain with a currency and interest-rate play. It didn’t work out. The weak link in his strategy: a bet China’s currency would remain strong.
In the rough-and-tumble world of global currencies, where exchange rates can swing by double-digit percentages in days, the yuan’s 3% fall against the U.S. dollar marked a minor change. But it is proving cataclysmic for investors like Mr. Huang who watched the yuan climb for a decade and anchored bets around the notion it would hold steady.
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The People’s Bank of China surprised markets by pushing the yuan lower on Aug. 11 in the nation’s biggest devaluation in two decades. A widespread view had taken hold that Beijing would support the yuan, rather than letting it fall in a bid to help exporters as China’s economy weakens, in order to prove its value as a global reserve currency.
Globally, the U.S. dollar has made powerful gains in recent months, but through early August, it had risen only 0.09% against the yuan since the start of 2015. For many investors, the low volatility was interpreted as low risk.
The currency change now adds to woes for China’s increasingly sophisticated investors, who tend to formulate strategies around predictions for government policy, including support for a strong exchange rate. Likewise, a plunge in Chinese stocks in mid-June confounded widespread views among investors that the government wanted a bull run, battering those who borrowed money in hopes of bolstering their equity returns.
In recent years, China has increasingly sanctioned the use of its currency in financial investment strategies. Nearly 150 banks in the internationalized market of Hong Kong now take deposits in the currency, and by last count those had reached nearly 1 trillion yuan, some US$160 billion.
To make use of that money, the financial industry has created investment opportunities involving the yuan. Some are plain vanilla: Investors can buy so-called dim-sum bonds that are denominated in yuan. Issuance by companies including non-Chinese ones exceeded US$35 billion worth in the past two years.
More sophisticated yuan-trading strategies include structured financial products, such as those that involve bets on the currency’s future value versus the U.S. dollar or euro. Tactics involve borrowing U.S. dollars to take advantage of low American interest rates while simultaneously making yuan deposits in higher-yielding, yuan-denominated wealth-management products, fixed-income investments and certificates of deposit, in a basic foreign-exchange play called a carry trade.
Some wealth advisers promise to turn a 3% annualized return into a 10% gain. But a prerequisite for a profit is that the yuan doesn’t fall. Suddenly, many of those deals are threatened.
Two days after last week’s devaluation, the cutting-edge Hong Kong fashion retailer I.T. Ltd. said it lost money because its deposits included 1.2 billion yuan, which is also known as the renminbi. I.T. told its investors in a statement that due to “recent volatility in the exchange of the Renminbi” the company anticipates a currency loss of 60 million Hong Kong dollars (US$7.7 million), an amount equivalent to a fifth of the company’s net profit in 2014.
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Following the devaluation, I.T. said it converted its remaining yuan deposits into Hong Kong dollar instruments.
“There has been a fair amount of pain,” said Khoon Goh, a currency strategist at ANZ Bank in Singapore, referring to investors caught off guard by China’s move.
Though the yuan’s 33% climb against the U.S. dollar since 2005 made it appear like a bastion of strength before last week’s currency move, past episodes have heralded the risk of volatility and even weakness in the Chinese currency.
Last year, the yuan took a hit against the dollar when the Chinese central bank suddenly increased the limit on daily moves in the yuan to 2% above or below its so-called daily fix, from 1%. The move caused a shakeout in the market for products called target redemption forwards, which gave investors a way to magnify gains from a rising yuan by deploying leverage, but exposed them to big losses when the yuan declined. It slid 1.4% during the week the band was widened.
Some investors appeared to heed the warning. As of March 2014, investment in currency- linked structured investment products—around one-fourth of them had a yuan component—had fallen by HK$114 billion from HK$214 billion in 2012, according to a survey published last year by the Hong Kong Securities and Futures Commission.
Another sign of rising caution about the currency is that once-booming growth in yuan deposits at banks in Hong Kong began to slow this year, just as China’s economy did. While total yuan deposits were still up 7% in June from a year earlier, according to figures from the Hong Kong Monetary Authority, they had fallen by 1% in the previous six months.
Rocky Cheung, head of investment product and advisory in wealth management at DBS Bank in Hong Kong, said more of his clients are now considering how to hedge their yuan exposure against possible further weakness, for instance by buying forward contracts that would offer insurance against further falls. He said others are keeping yuan in cash and short-term bonds, giving them more latitude to sell the currency quickly if conditions change more significantly.
China’s currency move shocked Mr. Huang, who runs his own firm in Hong Kong, Huihai Group.
The 39-year-old native of Jiangsu province had formerly worked at international banks in Singapore and Hong Kong, most recently as head of the Asia trade-finance business for a Spanish bank. At Huihai, opened a year ago, he puts together commodity trades and uses his finance skills to gain an edge.
In July, he paid a Chinese building-materials company $3 million for about 60,000 metric tons of coke, a commodity used in steel production. He had already lined up a buyer in Singapore who would pay a little more than that in September, giving him a profit in the range of 0.2% to 0.3% of the deal value.
Yet his real payoff would hinge on a 60-day deal he structured with a bank in Hong Kong that involved depositing US$3 million worth of yuan of his own money and borrowing the same amount in U.S. dollars, which he used to pay the Chinese coke exporter. The yuan deposit would yield an annualized return of 3.3%, more than the 2% annual interest he would pay on his two-month loan.
Instead of earning about $7,500 on the coke deal, he stood to gain more than five times as much, some $39,000 including the interest-rate arbitrage.
But when China’s central bank devalued the yuan, it slid as much as 3.8% in the offshore market, where the currency trades freely. Mr. Huang’s bank promptly emailed him with a request to deposit an additional 800,000 yuan, or roughly US$130,000, since the now-devalued deposit had served as collateral for his U.S. dollar loan.
Mr. Huang had the cash, moving it from another business. But it wiped out his profit on the coke-financing deal, leaving him with a paper loss of US$90,000.
“I never expected the yuan to fall off the cliff like this in such a short period of time,” said Mr. Huang. “This huge volatility is really bad for conducting normal business activities.”