Chinese Buying HK Stocks to Avoid Yuan Depreciation

Bloomberg: In Rush to Exit Yuan, China Traders Buy Sinking Hong Kong Stocks

Chinese investors are so desperate to shift their money out of yuan-denominated assets that they’re piling into some of the world’s worst-performing stocks.

Mainland buyers purchased Hong Kong shares through the Shanghai stock link for a 10th week last week, even as the Hang Seng Index tumbled 6.7 percent.

The premium in A-shares argues for owning H-shares over A-shares in most cases. As for depreciation, domestic shares might be a better choice if there's a flight out of cash in China. There are also domestic options such as this one: 国泰纳斯达克100(QDII-ETF) (513100), the Nasdaq-100 ETF. Of course Nasdaq has to rise, but that's a U.S. dollar asset that has no direct yuan currency risk.

I mentioned it back on September 7 as an option, it closed at 1.46 that that day. Today it closed at 1.512, for a gain of 3.5%. ChiNext is up about 10% since then, minus about 3% depreciation in CNY. Key point for buying Hong Kong shares though:

Because it’s a closed-loop design -- Chinese investors get the proceeds in yuan when they sell Hong Kong shares -- purchases don’t count toward an annual limit on moving money offshore, Citigroup said.

This make senses if the company in question has foreign assets and earnings, otherwise not so much.

China's Reserves Tumble $94 Billion in ~20 Days; Actions Speak

Bloomberg: China's Currency Stash Drops by $94 Billion After Devaluation

China spent much less on defending the yuan than some estimates forecast, with a burn rate of $94 billion. Deutsche Bank was spot on at the low end of their range, having forecast $100 to $150 billion. Depreciation began on August 11, so I'd venture they conservatively going to burn $125 billion in a month as things stand today. To put this "good" number in perspective, only a couple of weeks ago, a forecast of year-end reserves at $3 trillion was the most pessimistic forecast among 28 forecasters and traders surveyed by Bloomberg. This pace of decline translates into a year-end yuan target of 6.8 to 7 yuan per USD.

I think they may spend much more in the coming months though, because The initial run on the yuan was a reaction. Speculating on yuan depreciation was an obscure minority position up until about a month or two before it happened, when it grew to become a slightly less obscure position. The numbers aren't in China's favor, depending on how you estimate China's reserves or China's willingness to burn through reserves. Currency markets have a lot more firepower than even the PBoC and something that isn't really being discussed yet (I haven't come across much discussion at least) is the informational power of the offshore yuan. I keep harping on this idea because it is really central to understanding the threat to the yuan. The offshore yuan is a market price and everyone inside and outside of China knows it. The offshore yuan isn't yet a major reference point, but if currency risk rises on the list of Chinese investors' concerns, they will start watching the offshore yuan and react by either obtaining U.S. dollars or alternative assets such as gold. They may try to buy overseas assets, but the "going out" strategy is on hold. Bloomberg: China Freezes Outbound Investment Quotas as Outflows Hurt Yuan

The State Administration of Foreign Exchange, which has approved 132 local institutions to put as much as $89.99 billion in offshore assets via its Qualified Domestic Institutional Investor program, hasn’t granted new allocations since March. Quotas for overseas investors to access domestic capital markets rose $16.4 billion to $140.3 billion in the period, data from the regulator show.

Since equities are probably headed lower in the event of further yuan depreciation, investors may not want to hold foreign equities, but an ETF such as the Nasdaq 100 ETF (513100) might develop a premium if significant currency depreciation is expected and investors have limited options due to stricter currency controls.

The FT editoralizes: FT: Beijing faces up to its monetary trilemma

The first recourse for governments facing a currency crisis is to hope that it goes away. It is possible that it might: China has other ways to stimulate its economy that would enable it to sustain the tight monetary stance needed to keep the currency strong. The PBoC still has more than $3.5trn of reserves, enough to absorb more than two years’ capital flight at the current rate. Some will be tempted to see the volatility of the past month as just a passing summer storm, proof of the markets’ irrationality, and likely to evaporate if confronted with sufficient determination.

But however unpalatable the other horns of the trilemma, historical precedent suggests that waiting out a crisis can be the riskiest course of all.

I still expect a large, one-off devaluation that will surprise the market and completely end depreciation pressure.

In sum, China's reserve depletion wasn't as high as expected, but a month ago, this would have been a very negative result. Expectations have shifted. We have yet to see a major convulsion in the yuan, although there has been a lot of carnage in emerging market currencies. August is closer to the new normal than the peak of depreciation expectations.

The Herd Begins Moving Assets Abroad

Up until this point, outflows have mainly been driven by wealthy people moving assets out of China and into overseas real estate and investments. Financial reforms are opening up the world to smaller and less internationally savvy investors, and the recent dip in the yuan has spurred them to take advantage of new opportunities.

WSJ: Cash From China Is Boon for Hong Kong

China’s devaluation of its currency, its slowing economy and its tanking stock market have been a boon for Hong Kong’s money-changers, bankers and wealth managers, who are getting flooded with business from nervous Chinese eager to move cash overseas.

The flood of cash is affecting the HK dollar peg:

The flood of cash into Hong Kong has gotten so strong that the city’s de facto central bank was forced to act on Tuesday. In its first intervention since April, the Hong Kong Monetary Authority sold 15.5 billion Hong Kong dollars, or $2 billion, to the market in an effort to push down the currency, which was at the high end of the narrow band in which it is allowed to trade against the U.S. dollar.

At the same time as this is going on China Boosts Efforts to Keep Money at Home:

Some of the country’s largest lenders, including Bank of China Ltd. and China Citic Bank Corp., are beefing up their internal checks on large foreign-exchange conversions by corporate clients, according to Chinese banking executives.

Chinese companies can exchange yuan for foreign currencies only for approved business purposes, such as paying for imports or approved foreign investments.

Meanwhile, financial regulators, together with the country’s security forces, are stepping up efforts to rein in illegal money-transfer agents who make a living by helping people move money out of China.

I doubt these capital outlets will cause a breakdown in the yuan. What policy makers need to fear is a general run on the yuan. If ordinary investors decide the yuan will not protect their savings, they can buy gold, property, Bitcoin and overseas assets, including within China via an ETF tracking a foreign market. By shutting the door to capital outflows, China increases the odds of capital finding its way into an investable asset, one that will display momentum properties and attract the herd looking for a quick buck. All the government is doing here is diverting the flow into unforeseen directions.