China devaluation on deck

Market call for 2016:

I am usually not a fan of making market calls; I prefer “doing” to “talking”. Usually people making calls have something to sell, which is not really my case currently.

Now, 2016 is shaping like an extremely “interesting” year – interesting like the Chinese curse “may you live in interesting times” – and some of the trades I see for this year, I cannot actually make (unless somebody explains me how…), so I record them here.

The first one is that I see China devaluating the CNY (here I am mixing the onshore and offshore yuan/renminbi, both would fall by relatively the same amount) strongly this year (20-30-40%?). They are under strong market pressure to do so, have been leaking FX reserves at a faster and faster path and in general are doing a poor job of containing the problem.

They should, when they devaluated in August 2015, have done the full needed devaluation: USD gained between 20 and 50% depending on the considered currency, which has mechanically also increased the CNY value by the same amount against the rest of the world, killing the Chinese export machine. They should have bitten the bullet and devaluated 30-40% in 1 go at the time. By doing a little bit only, saying it was a one off event, and then doing it again a few days later, they scared a lot of CNY holding Chinese, really exacerbating the capital flight that has been ongoing for years now. With a one-off event, taking everybody off-guard, they could have regained their competitiveness while potentially attracting capital after the surprise receded. Doing it in small installment exacerbated the capital flight, forcing their hand on the devaluation. They will have to devaluate vs the dollar, unless the dollar itself crashes by 30-40% against the rest of the world currencies really soon (it will happen in time, but not fast enough for the Chinese).

My main issue here is that I do not know, as a retail investor, how to play that. No broker I know of offers the CNY as a trading currency (it is non-floating for a reason…). Also, China (Hong Kong to be exact) has recently raised the cost of short position carry to a really high value for a couple of days, to scare people who would consider shorting the currency, this is indeed scary, so the best way to play this would be through put options (1 or 2 years put I guess), but again, not accessible to retail investors and I have no clue about the cost of such puts. Another way would be through CDS on China, but not opened for retail, and in any case should we get a real event, I am quite certain excuses would be found in order not to honor the CDS (Greek “voluntary” restructuring to avoid “credit event” anyone?), so puts would be the best (assuming again that the counterpart from which you are buying the put would pay up… hard to be sure). One could consider shorting the Chinese market from abroad (keeping the CNY short exposure that way), but again not even sure it is allowed, and if it is, it will be forbidden the second your position starts making money…

In short, a really clear trade, but no good way to implement it…

Proxy trades for such devaluation are hard to find. I suspect other emerging market would follow suit and devaluate again (currency war), so shorting EM vs USD could be a trade, but it is quite pricy already, since the reason CNY must devaluate is that they are late to the devaluation party to start with.

I expect a lot of mayhem if it comes to pass, but mayhem we may have this year, with or without Chinese devaluation, so taking a position on that front now, could see much volatility even before the event, so I am not convinced.

In short, I will sit this one out unless somebody has a really good idea, I just want to record the call here, to be able to say “I told you so” later :D.


P.S.: the idea does not come from me only, I formed the idea reading various sources on the internet, and incorporating that with my macro-view and my bullshit-o-meter. The following article from TheAutomaticEarth, taken again by ZeroHedge, exactly on the topic, is in my opinion pretty much spot on and makes me feel things are close to a boil currently.

P.P.S.: read the disclaimer again.