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How to Trade a Chinese Yuan Revaluation

Treasury Secretary Tim Geithner said on Tuesday he planned to emphasize the need for a stronger Chinese yuan when he visits Beijing next week, amid some recent speculation that the country could relax its exchange-rate regime to some extent.

Eugene Hoshiko

Investors may want to trade on potential yuan movement, but without the ability to simply buy and sell the currency they will need to find proxies and other mechanisms to play the currency.

One option is the WisdomTree Dreyfus Chinese Yuan Fund – an exchange-traded fund that trades on the New York Stock Exchange as CYB.

Other proxies “investors have used in the past include South Korean won and the yen., but the best proxy is the won,” Andrew Busch, BMO Capital Markets global currency and public policy strategist, said.

The South Korean currency is the best replacement because the country exports a large amount of goods to China, and also because it is liquid, Busch said.

Chinese Premier Wen Jiabao has pegged the yuan's exchange rate against the dollar at around 6.83 since July 2008 to help Chinese exporters cope with a global recession, a move that frustrated Western policymakers.

At the heart of Congressional demands for a yuan revaluation is the argument that this would increase the number of American jobs by boosting exports to China, thus alleviating the recession - but some analysts are unconvinced.

“If China's currency strengthens substantially and our exports to China increase, then this could help create some more manufacturing jobs in the U.S., but the number of jobs would not be sufficient to fundamentally change the jobless crisis in the U.S,” Richard Hastings, consumer strategist for Hunter Securities told CNBC.com.

Steer Clear of Hong Kong

The Chinese stock market has dropped 25 percent since August, and many analysts have predicted that the Chinese economy is due for a rebound.

But investors banking on a boost in Hong Kong stocks to coincide with a yuan appreciation may be frustrated.

“This will not be good news for stocks in Hong Kong nor globally,” Diana Choyleva, Director at Lombard Street Research, said .

“Investors should position for an increase in risk aversion and a growth relapse globally.” “Exporters from China will be negatively impacted by a Yuan revaluation,” Choyleva said. “They could benefit from foreign direct investment flows, but because the Chinese government limits FDI, it's problematic.”

Don’t Sell Big-Box Retailers

Investors are also unlikely to gain from shorting companies highly dependent on cheap, Chinese-manufactured goods such as Wal-Mart Stores.

“A revaluation does not mean instantaneous price hikes for companies like Walmart.” Alexandra Harney, author of “The China Price: The True Cost of Chinese Competitive Advantage,” said.

“The first companies to take the hit from a renminbi revaluation will be China's exporters, because retailers and brands buying from China will resist price increases for as long as they can,” Harney said.

“Wal-Mart is so good at keeping costs low that it (a revaluation) won't affect it much,” Busch added. But he argued that it’s not the yuan, but euro oscillations will rattle the markets, and investors should keep one eye focused on Europe.

“Even if you're right on direction of yuan, you could lose money because markets are heading towards a strong US dollar,” he said.

“I suggest going short euro, long South Korean won,” he added.

When to Expect a Revaluation

There still isn’t a clear consensus on whether China will revalue their currency several weeks or several years from now.

“The falling euro dramatically reduces the chance of China upward valuing the yuan because of fear of even further erosion of competitive advantage in its largest export market,” Peter Navarro, Author: The Coming China Wars, Always a Winner, said.

“The fact that China has held its peg has been a major contributor to weak growth in Europe,” he added. “That will continue.”

But others disagree. “A yuan revaluation in the context of an overall Chinese tightening is likely this year,” Choyleva said.

“The Chinese have been under a lot of pressure to do this (revalue), and they're going do it in their own time, when it’s in their best interest. It is in their best interest right now, as they’re pressured by inflation,” Busch said. “But I don't believe they'll be very aggressive.”

“They may allow the yuan to appreciate against dollar gradually,” Choyleva added. “But at the end of the day, it’s a communist government that doesn’t believe in releasing control.

"The financial crisis has convinced them that their market methods are better than the West.”