Special Report: Is The Yuan Undervalued?

• 5 Apr 2019

As China becomes a more consumer-orientated, developing economy the Yuan will continue to strengthen and stabilise, specifically against the US Dollar. Any products you buy now in China will cost you considerably more than even a few years ago. According to The Economists’ Big Mac Index, in the last 10 years, the Yuan or RMB has appreciated almost 27% against the dollar. The appreciation comes despite a devaluation by the People’s Bank Of China in 2015 which saw the Yuan lose 3% of its value. The markets were rocked as the move represented the sharpest devaluation in 20 years.

What is the Big Mac Index? Originally the metric was developed as a loose indication of how global currencies were performing against each other and measures the over or undervaluation of currencies. The basis of the index is purchasing power parity (PPP), which means that an optimal exchange rate is one in which international payments should be balanced over the long term, or the same goods should cost the same in any two countries.

So how does the Yuan measure up?

 *Economist Big Mac Index: https://www.economist.com/news/2019/01/10/the-big-mac-index

 **Burger prices taken from online order form on McDonald’s website.

Current calculations suggest that the Yuan is undervalued, by 36% against the U.S. Dollar. The actual exchange rate at the time of writing is at 6.71 Yuan to the Dollar. But burgernomics suggest otherwise; that, in fact, the implied purchasing power parity is closer to 4.27 Yuan to the dollar. So, the Yuan is actually less expensive than the implied PPP. In fact, if you are an American citizen travelling to China and you decide to buy a Big Mac it would only cost you the equivalent of $3.43. So what does this all mean? Should you start buying up Yuan and investing in Chinese companies? Perhaps. It is important to be aware of the limitations of such metrics, namely, the lack of measurement of labour costs or GDP per capita.

In order to value the Yuan as a potential investment, we cannot ignore fundamental factors currently impacting the currency. The impending Sino-U.S. trade war has negatively impacted both currencies as the opposing administrations have implemented tit-for-tat trade policies. The Yuan suffered more than the dollar in the last year, however, as the Federal Reserve provided support for the greenback by raising interest rates. Further tensions will only weaken the USD/CNY further.

Although there are suggestions that the PBOC has intervened to facilitate further depreciation of the Yuan in a bid to absorb the impact of U.S. tariffs, there are also indications that the weakness is justified. The combination of falling domestic and global growth coupled with Fed policy are just some market forces impacting the currency. The Hang Seng (HK50) will be directly affected by these trade negotiations which by all accounts are progressing well. Given the interests of both administrations for the talks to go well, it seems likely that a deal will be made although the negotiation period may be longer than originally anticipated, causing further volatility. The fact that China is a net exporter and economic growth is dependent on the economy’s ability to be competitive on pricing; it seems likely the weakness in the Yuan will continue, especially if the PBOC intervene. Therefore as discussed, we are likely to see a decline in the HK50 if political instability and slow growth persists.

Lastly, we must review the technical situation for the Hang Seng Index (HK50). How does all this information affect our investments? The HK50 represents some of the top companies in China namely Tencent and ChinaMobile and clearly Yuan weakness and political tensions will impact China’s major corporations. The index has declined in the last year as the impact of tariffs has begun to sink in.

The HK50 has reached a key resistance area at the 29,990.64 price level spiking, but unable to break, the resistance level as buyers were pushed back and the index closed below the 29,990.64 price level. At the same time, we have a ‘death-cross’ of the 50 day simple moving average (SMA) and the 100 day SMA, which in itself is a bearish signal. From a momentum perspective, RSI is approaching ‘overbought’ conditions which generally signals a potential reversal. A break in the rally at the 28,757 price level was the first sign of waning appetite from buyers. Unless the index can break the 29,990.64 price level, the most likely scenarios is a period of weakness.

In conclusion, investors may wish to take a longer-term bearish view and target 29,990 resistance level (+ 10% as a safety net) with buyers potentially losing steam at this resistance level.