As a veteran trader, I have a tendency to look past the day’s top headlines.
That’s why a recent Bloomberg News story – which stated that China sold a net total of 769.2 billion yen ($9.24 billion) worth of Japanese debt in September – really caught my eye.
By itself, this story probably wouldn’t be a big deal. But this development is the start of an important new trend in the global currency markets. And the following three factors tell me that we should be taking a close look at why China has decided to dump Japanese debt. For instance:
- Given that the same thing happened in August, September marked the second straight month Beijing has sold more Japanese securities than it purchased.
- This marks the reversal of a seventh-month stretch of China being a net purchaser of Japanese debt.
- The two months of sales nearly wiped out the net surplus of 2.32 trillion yen ($27.86 billion) that China had amassed as a result of seven months of buying Japanese debt.
- Finally, the 2.02 trillion yen ($24.26 billion) worth of Japanese debt that China sold in August was China’s single-largest monthly sale of Japan government bonds since 1995, when these statistics first started being recorded.
[ad#Google Adsense]While there are other conceivable explanations, my take is that China is definitely unloading its yen-denominated holdings, and shifting its investments elsewhere as part of a much bigger reallocation strategy. As investors, this is a trend that we need to track – and to react to.
Let me explain….
A Signal From the Trading Pits
The two months of net selling of Japanese debt is not a co incidence. It suggests to me that Chinese traders may believe the Japanese yen is topping out and will likely move lower in the weeks and months to come.
In fact, in the days since I initially spotted this potential trend, that’s precisely what’s happened.
The yen traded at its highest level in more than 15 years on Nov. 1, being quoted at 80.22 per U.S. dollar. That was just slightly below the all-time-record high of 79.75 that was established on April 19, 1995.
By Friday, Nov. 5, the yen had slipped back to 82.37 per dollar. It was trading at 83.2616 per dollar yesterday (Monday) afternoon.
And mark my words – the yen is likely headed even lower.
China pays particular attention to the strength of the yen because the Japanese debt it holds provides an extremely low yield – less than 9/10ths of 1.0% on 10-year securities, and as little as 1/10th of 1.0% on some short-term instruments.
That means that most of the gains China makes on its holdings of Japanese debt must come from currency fluctuations. So it’s also possible China is simply taking profits.
Either way, we’d be wise to listen: During the worst parts of the global credit crisis a year ago, China adopted a similar course of action by cutting off purchases of European and U.S. debt – opting instead to buy much “safer” yen-denominated assets, and other “currencies” like oil, gold, and to a lesser degree, silver. All of these assets embarked upon their latest upward run right about the same time. All of them are capable of “preserving” wealth, which is what Beijing seeks.
Here’s how I read this latest move: China – having achieved its goal of reserve diversification – is now looking to diversify away from the yen as a means of additional risk reduction and wealth preservation.
Given that China’s currency reserves have swelled to a staggering $2.65 trillion (based on the latest estimates), this won’t be a trivial move. With its shift toward consumerism, China may be forced to make other, related moves if the Asian giant is to continue its trend of reasonably orderly growth.
Investment Moves to Make Now
For most investors, the reasoning behind such moves as China’s divestiture of Japanese debt isn’t as important as the profit opportunities that should result.
I completely understand that sentiment – which is why I’ve put together three recommendations for your consideration. If you want to profit from China’s sale of Japanese debt:
- Short the Japanese yen versus the U.S. dollar: Tokyo frequently objects to China’s actions with respect to Japanese debt – criticizing the restrictions that Beijing puts on equal access to the Chinese debt markets. Thus, it’s unlikely Tokyo will put up with the current situation for long. Japan could decide to weaken the yen if China continues to unload Japanese debt, thereby wiping out China’s currency gains. At the same time, selling pressure from Beijing could escalate and that would overwhelm any buyers of Japanese debt at these high levels. The modest rally in the dollar versus the yen we’ve seen over the past few weeks suggests that this has all started to play out.
- Invest in the Chinese yuan: As the yen weakens, China’s currency will – by necessity – increase in value. The easiest way for the typical retail investor to do this is to deposit money with EverBank(**), specifying that the online institution place your funds in its yuan-denominated WorldCurrency AccessSM Deposit Account. As an alternative, you might also consider buying shares in the exchange-traded WisdomTree Dreyfus Chinese Yuan Fund (NYSE: CYB), recent price $25.41.
- Buy commodities: As noted above, China has nearly $2.7 trillion in foreign currency reserves – and if Beijing isn’t going to continue investing yen, there’s nowhere else for the Asian giant to go but into hard assets. That will help maintain the upward-price pressure on metals, energy components and high-demand agricultural products – which, though not technically hard assets, still merit consideration – even after the recent pull back. There are plenty of exchange-traded funds (ETFs) that focus on commodities, hard assets and even agricultural products.
— Keith Fitz-Gerald
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Source: Money Morning