Jim Rogers Buying the Yuan

[john kane]

sorry i havent replied sooner.

when i amazoned ITA i got: http://www.amazon.co.uk/Intermarket-Tech...0702&sr=8-3

but i now see i could buy it for £57 ($120)

http://www.amazon.co.uk/Intermarket-Tech...0702&sr=8-3

or £25ish ($50) for a seller on amazon: http://www.amazon.co.uk/gp/offer-listing...0760&sr=8-1



also how do i trade on CME??? it is the only place which seems to offer renminbi futures but i see no way where it explains how to set up an account! please help!!

[ItalianFX]

Those first two links aren't even the right book.

The 3rd link is correct.

I don't think you can trade directly with the CME. You'd probably have to go through someone else.

[ItalianFX]

I forgot to mention. I ordered the book on Friday night and got it for about $28 after S&H. I can't wait for it to get here.

[PairTheBoard]

I would think there must be a big premium for Yuan futures over the current exchange rate. If China maintains the current peg through the life of the future you end up losing the premium. With big leverage that could be a big loss, no? You are essentially betting that the market has underestimated, by way of the premium, the probability that the Yuan will be forced to float and its degree of rise if it does so. I don't see how rolling the contract over to a new one avoids your loss of the premium you paid for the current one, if you get unlucky and the Yuan remains pegged. The upside if you get lucky could be huge though.


On the other hand, if you buy the Yuan outright you eliminate the risk of losing your investment outright as above. But you take on the risk of suffering the wrong side of the Carry between the Yuans lower interest rate than the dollar. That's the loss you suffer if again you get unlucky and the Yuan remains pegged. You probably can't do this with the same leverage as the futures so both the risk and reward are moderated. But it seems to me the advantage here, assuming you can buy the Yuan where China is pegging it, is that you avoid paying a premium determined by free market forces like with the futures. I think you might get a better piece of the value from the artificially produced exchange rate. This is evidently what Jim Rodgers is doing.


PairTheBoard

[DcifrThs]

[ QUOTE ]
I would think there must be a big premium for Yuan futures over the current exchange rate. If China maintains the current peg through the life of the future you end up losing the premium. With big leverage that could be a big loss, no? You are essentially betting that the market has underestimated, by way of the premium, the probability that the Yuan will be forced to float and its degree of rise if it does so. I don't see how rolling the contract over to a new one avoids your loss of the premium you paid for the current one, if you get unlucky and the Yuan remains pegged. The upside if you get lucky could be huge though.

[/ QUOTE ]

but if that were true (the futures price has a premium that the spot doesn't) you could make a risk free profit by selling the futures contract and buying the yuan in the spot with money borrowed at the prevailing mkt rate (in the USA since you are effectively short the future yuan. i think i have that right though i haven't written it out as a formula to verify).

the point here is that the futures prices and the spot prices are 100% tied together so long as there is a way to short/long both spot and futures prices, which there is in this case.

so if the futures price has an absolute premium tied to it, the spot would have to rise as well (since people would buy the spot and sell the futures). but the chinese central bank has sold the spot down and thus the spot will actually tie the futures price down instead.

i haven't dug into this with the data but i'd conjecture that is the case as it is the case with all futures prices that have low carrying/storage costs, can be bought/sold in both the future and spot.

[ QUOTE ]

On the other hand, if you buy the Yuan outright you eliminate the risk of losing your investment outright as above.

[/ QUOTE ]

the above example though is falacious...and not the good kind.

[ QUOTE ]
But you take on the risk of suffering the wrong side of the Carry between the Yuans lower interest rate than the dollar. That's the loss you suffer if again you get unlucky and the Yuan remains pegged.

[/ QUOTE ]

again though, if that were the case why wouldn't you sell the futures and buy the spot?

[ QUOTE ]
You probably can't do this with the same leverage as the futures so both the risk and reward are moderated. But it seems to me the advantage here, assuming you can buy the Yuan where China is pegging it, is that you avoid paying a premium determined by free market forces like with the futures.

[/ QUOTE ]

if there were a premium determined by the free market, while the spot is pegged and can be purchased it would be arbed out. period.

[ QUOTE ]
I think you might get a better piece of the value from the artificially produced exchange rate. This is evidently what Jim Rodgers is doing.


PairTheBoard

[/ QUOTE ]

i don't know what jim rodgers is doing and i'm too lazy to look up at the initial post lol...i'm assuming jim rodgers is doing whatever he thinks is best.

the real issues here are the tax issues (are there >12mo futures contracts available and can that be treated as cap gains?? what about daily margin gains losses? are those treated as short term trading? that would be hugely detrimental so i don' tthink that is th case).

hope this helps and let me know if i've made any incorrect statements.

thanks,
Barron

[PairTheBoard]

[ QUOTE ]
hope this helps and let me know if i've made any incorrect statements.


[/ QUOTE ]

We need the actual price quotes for the futures to compare them to the actual spot price quotes to know who's right. I don't see your logic myself. If you borrow at dollar rates to buy and hold Yuan at Yuan rates, using the Yuan to settle the 1 year futures contract you've sold in them you will at least need to charge a premium for the contract to cover the expected losses on the interest differerential for the year. There is virtually zero probability the Yuan will be unpegged and revalue against the dollar right now today. Most people think that probability is greater than zero for the event to happen some time in the next year. The market should be willing to pay some premium on the futures for that probability.

If you are holding Yuan for the year in order to settle a futures contract which you compute has a higher EV than the spot price because of that probability, you should insist on recieving a premium for insuring that delivery. Yes you can make money with this trade but that doesn't mean so many people will do it that the premium gets arbed to zero. If it gets driven down below the EV on the Future Yuan, other people will take the other end of it and make money there as well. What should happen is the premium finds some kind of equilibrium in the middle where both sides can make money or +EV. You might ask, how can that be? There seems to be free money to be made on both sides. The reason is that China is providing that free money by overpaying for Dollars to begin with and everybody knows it.

At least that's my logic. The proof of who's right is in the actual price quotes if we can get them.

PairTheBoard

[DcifrThs]

[ QUOTE ]
[ QUOTE ]
hope this helps and let me know if i've made any incorrect statements.


[/ QUOTE ]

We need the actual price quotes for the futures to compare them to the actual spot price quotes to know who's right. I don't see your logic myself. If you borrow at dollar rates to buy and hold Yuan at Yuan rates, using the Yuan to settle the 1 year futures contract you've sold in them you will at least need to charge a premium for the contract to cover the expected losses on the interest differerential for the year. There is virtually zero probability the Yuan will be unpegged and revalue against the dollar right now today. Most people think that probability is greater than zero for the event to happen some time in the next year. The market should be willing to pay some premium on the futures for that probability.

If you are holding Yuan for the year in order to settle a futures contract which you compute has a higher EV than the spot price because of that probability, you should insist on recieving a premium for insuring that delivery. Yes you can make money with this trade but that doesn't mean so many people will do it that the premium gets arbed to zero. If it gets driven down below the EV on the Future Yuan, other people will take the other end of it and make money there as well. What should happen is the premium finds some kind of equilibrium in the middle where both sides can make money or +EV. You might ask, how can that be? There seems to be free money to be made on both sides. The reason is that China is providing that free money by overpaying for Dollars to begin with and everybody knows it.

At least that's my logic. The proof of who's right is in the actual price quotes if we can get them.

PairTheBoard

[/ QUOTE ]

i got the quotes and we are probably both right.

CNY deposit rate= 3.60%
USD deposit rate= 5.00% (six month CD was 4.933 so i just upped it a bit for 1 year though it is probably a bit conservative)

USD/CNY spot rate as of Oct 26 2007= .13338
USD/CNY futures rate as of this morning= .13995

implied USD/CNY spot rate priced off of futures taking into account the IR diff (only) = .138084

implied USD/CNY futures rate priced off of spot taking into account the IR diff (only) = .1351784

so that leaves us with a 3.41% underpricing of the implied futures vs. the actual quoted futures (i.e. the quoted futures are more highly priced)

now, on the face, that seems to imply that you are right...but if so, why is the "premium" so small?

so i tested this and did the same thing for JPY/USD and found that the JPY/USD futures priced off the spot * IR diff was underpriced by 1.40%.

basically, what i found here is obvious: interest rate diffs aren't the only thing that determine futures prices (mostly b/c present interest rates diffs are supplemented by future expected interest rate diffs during the year and right now we expect more cuts in the US) EDIT: and in these two cases, the futures prices are too high relative to spot * IR diff. i'm sure if i looked at the EUR or GBP Or some non-asian country (or one that will likely see rates fall int eh coming year) the futures price woudl be more in line.

but i did find evidence of one thing: that interest rate diffs do keep the spot and futures prices tied within bounds as i mentioned in my post.

so in the end, i think we are both right.

you are right that there is a premium priced in.

i am right that the spot and futures prices are tied together by (among other things) the IR diff between the two currencies (and that they are tied together via trading/arbitrage)

i'm very comfortable betting that the 3.41% "premium" is WAAAAAAYYYYY small relative to what it will turn out to be in a year (i.e. the spot price has kept the futures price tied down via arbitrage). the yuan has appreciated 3.27% since just may 7 2007 and neither the chinese economy nor the inflation expectations there have been reduced at all...AND the olympics will certainly bring significant inflows of capital to china pushing up the currency.

Barron

[PairTheBoard]

[ QUOTE ]
i'm very comfortable betting that the 3.41% "premium" is WAAAAAAYYYYY small relative to what it will turn out to be in a year (i.e. the spot price has kept the futures price tied down via arbitrage). the yuan has appreciated 3.27% since just may 7 2007 and neither the chinese economy nor the inflation expectations there have been reduced at all...AND the olympics will certainly bring significant inflows of capital to china pushing up the currency.


[/ QUOTE ]

Thanks for getting those figures Barron. That gives us the full picture. That premium is smaller than I expected. However, I'm still not convinced about your interpretation. If enough money were put into purchases of futures based on your evaluation of the future EV for the USD/CNY then I don't think arbitrage could hold the futures price down. If market guesses about coming U.S. interest rate cuts can drive up the futures price despite arbitrage then so can market guesses about future values of USD/CNY. After all, isn't that what the market is trading? Money pouring into the futures would bid their price up. The market just doesn't share your view. But that's actually a good thing if you're right about future values of USD/CNY and you make the bet.

Edit:
Thinking some more about how expectations of U.S. interest rate cuts affect the dynamic. From the viewpoint of the arbitrage player, this reduces his expected cost due to the interest rate differential. Thus the premium due to that factor should actually be less than it would be based on current interest rates. Yet it's more? Why? If that really is the factor the reason would be because it causes the market to expect the dollar to weaken further thus causing future values of the USD/CNY to be greater, if China allows it. So even with this factor it is the market's view of future values for the USD/CNY exchange rate that is driving the premium.

If the market knew for a fact that China was going to unpeg the Yuan in say 11 months but keep it pegged right now you can bet your house that so much money would flow into Yuan futures that all the arbitrage in the world would not hold the price down. People would still certainly borrow dollars to buy Yuan right now. But they wouldn't waste their Yuan on little premiums selling USD/CNY futures contracts barely above current spot prices. They would just hold the Yuan for 11 months.





PairTheBoard

[DcifrThs]

[ QUOTE ]
If the market knew for a fact that China was going to unpeg the Yuan in say 11 months but keep it pegged right now you can bet your house that so much money would flow into Yuan futures that all the arbitrage in the world would not hold the price down. People would still certainly borrow dollars to buy Yuan right now. But they wouldn't waste their Yuan on little premiums selling USD/CNY futures contracts barely above current spot prices. They would just hold the Yuan for 11 months.

[/ QUOTE ]

whats funny here is that i re-read my posts and one of the conditions for the spot-futures relationship wasn't mentioned. namely, the spot price has to be free to move.

in the example you gave, china could keep their currency pegged for those 11 months (albeit with increasingly large costs since everybody would be clamoring for yuan) and the futures price would increase significantly b/c the spot price cannot move despite all the buying.

you are also correct that PBOC is providing the free money here (which goes back to why i think currency markets present some of the biggest opportunities and can be very inefficient) since they are basically the only ones willing to sell yuan.

in all smoothly traded futures markets though (where both sides are free to move and you can long/short both spot and futures), the prices are tied together via arbitrage.

Barron

[ItalianFX]

After reading the excerpt on Amazon.com, that Intermarket book stated that if the Dollar is up, Commodities should fall, and bonds/stocks should go up.

Well, if the dollar has been down, and the commodities have been up, that should mean bonds/stocks should be down. However, stocks have been up. How do we explain that and how do we react to it?