Oxstones Investment Club™From WSJ,
The U.S and the International Monetary Fund are pressuring China to let its currency, the yuan, climb in value. Big banks, including Goldman Sachs Group Inc. (NYSE: GS – News) and Citigroup Inc. (NYSE: C – News), have told investors to bet on a rising yuan.
But a number of investors with unconventional views are placing gutsy wagers against the yuan.
The moves have caused some rivals and observers to scratch their heads or even scoff. China has kept its currency within a tight band, one that is expected to rise about 5% annually. With inflation high, authorities have an incentive to keep the currency strong, keeping a lid on import prices. And China has about $3 trillion of foreign-currency reserves that could be sold if the yuan came under pressure as a way to prop up the currency.
Yet contrarian investors, some with strong track records, are attracting attention with bearish trades that could pay off in a huge way if the yuan falls.
Their rationale: China’s economy is a bubble waiting to burst. Some said China is sitting on huge debts that will haunt it as real-estate prices slip further, and that authorities won’t be able to forestall inflation without severely slowing the economy. If the economy does sputter, officials may devalue the currency to boost revenue from exports, yuan skeptics said.
Even if the chance of a yuan collapse is low, the possible payoff is too huge to ignore, some said.
“Given the magnitude of China’s credit problems, it’s at least a possibility that the yuan drops sharply,” said Cullen Thompson, managing partner of Bienville Capital Management LLC, a New York investment firm placing bets against the yuan. “The potential of the trade is so great, and when there’s cheap insurance in today’s environment it’s silly not to buy it.”
While China controls the amount of yuan going in and out of the country, the bears argue those restrictions are being loosened and aren’t as ironclad as some may think. And in a crisis, they said, foreign companies and investors will find a way to pull money out of the country.
Just as those who wagered against the U.S. housing market before the bubble burst generally weren’t well-known firms or industry specialists, those placing bearish yuan trades often are smaller firms. As upstarts, they can be more willing to buck the conventional view. Their clients are often able to withstand small losses in return for hopes of big profits down the road.
Bienville manages about $300 million and searches for asymmetric trades: those that are cheap enough to offer big upside and limited downside. The Broyhill Family Office in Lenoir, N.C., which manages about $300 million for the family that founded Broyhill Furniture and other wealthy families, also recently placed bearish yuan trades.
Mark Hart, who runs Corriente Advisors LLC, a Fort Worth, Texas, hedge fund, anticipated problems in subprime mortgages and debts of European nations. Mr. Hart said last month that he has made bearish yuan trades because China’s economy is a “credit-fueled bubble.”
Here is how the trade usually works: An investor purchases a put contract from a bank, or a contract giving them the right, but not the obligation, to sell yuan and buy an equal amount of U.S. dollars at a set price. The cost of a one-year contract allowing the investor to sell $10 million of yuan at 20% below current levels over one year costs just about 0.15 percentage point, or $15,000.
If the yuan tumbles below that strike price, say to 8.5 for each dollar, or about 30% below the current level, the put contract would soar in value, leading to a profit of about $850,000 from the $15,000 investment, or a return of about 5,500%.
Even if the value of the yuan becomes more volatile, but doesn’t fall, the value of the contracts would rise.
Despite the huge upside to these yuan trades, some China skeptics, such as hedge-fund manager Jim Chanos, prefer to target other Asian investments that could be affected by a Chinese downturn.Some investors don’t have a mandate from clients to wager on currencies; others think China will slow but the currency will hold up.
It can be harder for bigger firms to place bets against the yuan in a large enough size to make it worthwhile. And some investors have been wary of bearish trades because the currency has been robust for so long. On Tuesday, the yuan’s value was moved slightly higher to 6.4690 per dollar from 6.4696 on Monday.
“Good luck betting against a $3 trillion reserve currency,” said George Papamarkakis, co-founder of North Asset Management LLC, a London hedge fund. “It’s a way-too-premature trade.”
The currency’s level still is largely controlled by the government, and even though China has taken steps to foster offshore trade, the amounts are limited. Most of the trading is in the market for nondeliverable forwards in yuan, essentially a derivative that doesn’t give the owner possession of the currency.
Still, Goldman Sachs last week told hedge funds to exit a bullish bet on the yuan, according to an email to clients.
The recommendation from the firm came amid concern that consumer prices, which rose 5.5% in May from a year earlier, could climb higher unless officials take more forceful steps to cool the economy. Goldman continues to predict the yuan will rise further, just not as quickly as it once expected, underscoring how unorthodox bets against the yuan remain.
That is exactly what attracts some bears.
“With the entire world and their grandmothers looking for a yuan revaluation and continued inflation, I’m willing to a put a few chips on the table to wager that something in China may break along the way,” hurting the yuan, said Christopher Pavese, Broyhill’s chief investment officer.
In other currency news, the euro advanced as Greece moves to make economic overhauls to cut its sovereign debt.
Late afternoon in New York, the euro was at $1.4411, up from $1.4303 late Monday. The dollar was at ¥80.20, down from ¥80.26. The U.K. pound was at $1.6245, up from $1.6202. The euro bought ¥115.58 from ¥114.79. The dollar was at 0.8421 Swiss franc from 0.8405 franc.
Write to Gregory Zuckerman at gregory.zuckerman@wsj.com and Neil Shah at neil.shah@dowjones.com
Tags: Asia, bearish yuan trades, China, china credit bubble, China inflation, chinese bearish bets, chinese real estate bubble, chinese yuan, contrarian investing, investing in currencies