Want A Yuan Play? Look To Commodities

June 22, 2010

Maybe the best way to play the Chinese yuan, Matt, is to not play it at all.

You're right when you say that taking a direct stance in the newly "flexible" Chinese currency via the WisdomTree Dreyfus Chinese Yuan ETF (NYSEArca: CYB) or the Market Vectors Chinese Renminbi/USD ETN (NYSEArca: CNY) isn't exactly instant gratification. As you point out, these funds offer exposure to currency futures, not spot yuan. So if you're trying to access near-term appreciations in
’s currency, you're bound to be disappointed, because these are markets where expectations for prices several months in the future often matter more than any short-term central bank decision.

But most investors aren't really interested in instant gratification, anyway.

I think there's a more interesting story here than just the yuan's effect on CYB. After all, CYB is only a measure, a yardstick, to gauge how many dollars the yuan can buy right now. But rather than thinking about a stronger yuan simply in terms of how much
could buy, I'm more interested in what they'll be buying.

And the answer to that, I think, is clear: commodities.

is the biggest buyer of hard assets in the world, most of which remain priced in U.S. dollars. So naturally, if the yuan is now free to appreciate relative to the dollar,
's commodity buyers will be able to snap up more goods as their currency strengthens.

So it just makes sense that we'd probably see price bumps in those commodity markets where supply is tight, particularly in base metals, like copper, aluminum and iron ore. A stronger yuan means Chinese buyers can buy even more, and put further pressure on supplies.

A recent Wall Street Journal article offered a telling example: If the yuan had been allowed to appreciate just 3 percent relative to the dollar in 2009, it could have saved the country nearly $3 billion in copper and iron ore import costs—money that could've been reinvested in importing another 35 million tons of iron ore.

Tighter supplies would lend support to prices in diversified base metals funds, like the PowerShares DB Base Metals ETF (NYSE Arca: DBB), which invests equal amounts in copper, aluminum and zinc futures, respectively. Likewise, the iPath ETNs tracking futures of the individual metals, such as the DJ-UBS Aluminum Subindex Total Return ETN (NYSEArca: JJU) and DJ-UBS Copper Subindex Total Return ETN (NYSEArca: JJC), could also see a yuan-related bump to the upside.

Of course, like with CBY, a bolstered yuan won't necessarily translate into a base metals boom overnight. But, fundamentally speaking, a robust yuan is good for certain commodities, and their associated ETFs, over the long haul.

But not all commodities would benefit. After all, far more goes in to setting a commodity's price than just a simple exchange rate.

For starters, agricultural commodities would probably shrug off any effects from an appreciating yuan—at least for the next several months. Ags are strongly seasonal and have a fixed supply schedule from year to year, based on forecasts made many months prior. Just because
has an insatiable appetite for soybeans, and a stronger yuan would make it possible for them to buy more, doesn't somehow magically make more soybeans appear on the market.

In addition, should the yuan appreciate too much, commodities that
China exports in large quantities are likely to suffer, notably steel.
is already the world's largest steel producer, accounting for nearly half the world's production in 2009. We've also seen the Market Vectors Steel ETF (NYSEArca: SLX), an ETF of steel producers, rise more than 39 percent over the past year. But will the good times continue, if a stronger yuan means export partners have to pony up more dollars or euros to buy the same amount of steel as before? Probably not.

In the end, it's all a waiting game to see just how far and fast the yuan rises—if at all. But if the yuan does rise, the best long-term play might be to focus less on the currency itself, and more on what that currency can buy. After all, money makes the world go round.

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