Buy puts on the yuan?

From John Mauldin's Thoughts From the Frontline: Changing the rules in the Middle of the Game

“We saw today that 80% of Chinese construction firms say developers are now behind on payments (late cash flow), and that consequently land purchases are already 42% down y/y (slowing local authority cash flow). We also heard that pricing controls means that utility companies no longer have the cash flow to afford vital imports. Q3 corporate cash flow was down 27%.

“China's trade surplus is annualizing this year at USD152bn, FDI [Foreign Direct Investing] @ USD114bn yet its FX reserve increase is USD472bn. The attached chart [below] shows Chinese external borrowings which unfortunately were last updated at the end of last year, but the data would infer these have continued to soar.

“I am being told that European banks are now starting to shrink their foreign loan books to meet domestic needs, with Mexico, Brazil and China all big losers. With China now saying they may run a full-year trade deficit next year, and with them unable to afford to import vital coal and other resources without either suffering domestic inflation or without selling its FX reserves, it may now well be time to consider some sort of puts on the yuan. In fact the only reason perhaps not to is that India may collapse first, reducing the competition for coal and giving China a little more breathing room.

Using a fund such as ProShares Ultra Short China (FXP) may be the best route for retail investors to directly short a decline in the renminbi, although there will be numerous knock-on effects and funds such as PowerShares DB Base Metals Double Short ETN (BOM) should also do well. Direxion Daily Emrg Mkts Bear 3X Shares (EDZ) would also likely be a winner.

I haven't discussed my Marketocracy portfolios in awhile, but I have these types of ETFs in my China fund, which is up about 2% this year. The gains were mainly from a large gold position, which was the largest holding; it's now a very small position. The aim of the fund is to be a play on China, holding either Chinese stocks (always some), but also commodities and currencies related to China. Chinese are heavy gold buyers, hence the gold position. Europe is the largest export market, so ProShares UltraShort Euro (EUO) or PowerShares DB U.S. Dollar Index Bullish Fund (UUP) get added during crisis periods. The largest position is currently FXP, with short funds totaling about 33% of assets, which works out to effectively 70% short exposure based on leverage. Cash is near the mutual fund regulated limit of 35%, with short term bonds upping that to about 40%. My timing has been bad with the short funds, but I'm still of a mind to increase short positions if the market rallies. If timing remains an issue, I'll just move to cash equivalent assets and ETFs such as UUP to ride out the storm.

August Performance

Index	August %	YTD %
S&P 500 TR	3.61	14.97
MSCI EAFE	5.16	21.14
上海 Shanghai	-21.80	46.51
Fund
Entertain. Trends	0.31	20.96
Green Dragon	-0.25	28.84
Best of Funds	-2.64	5.20
Pharma & Dogs	-1.04	5.89
China Fund	-0.85	11.28
Software Security	-2.37	25.43
Yield to Me	-0.81	11.52
Catch a Falling Knife	-5.54	-46.74

I went heavily bearish in my Best of Funds, with large positions in TLT, UUP, FXY, plus multiple positions in inverse ETFs such as FXP, SRS, SKF, EEV, QID, DTO, etc. It started paying off at the end of August, but I'm ready to reverse if the market climbs higher.

China Fund also has a large neutral position plus bearish with heavy FXP exposure.

Other portfolios have raised cash or moved to more defensive holdings.

May Performance

_____________May %_____YTD %
Indexes
S&P TR_______5.59______2.96
EAFE________11.09______6.46
SSE上海______6.27______44.60
My Funds
GreenDr_____6.71_______23.65
Pharma______5.56______2.44
Yield________11.99______11.71
Software_____8.33______19.42
Entert_______4.78______12.64
Best_________6.80______15.10
Short_______-14.40_____-34.33
China________0.92______5.71

Changes in May:
I had to sell positions out of the short fund to keep positions below the 10 percent limit. The fund is loaded up on the garbage that shot higher the past three months, click the link to see a chart that looks like Everest.

In the Best of Funds, I closed shorts on oil, gold and real estate, and entered shorts on U.S. long-term treasuries. I also increased the cash portion of the portfolio to the limit of 35 percent. Considering the short hedges I had in place, and the large cash position that was over 20 percent to begin the month with, the 6.80 percent return versus 5.59 percent for the S&P 500 Index is an acceptable performance, but considering the strength of gold mining stocks last month, I suffered for my heavy defense.

In the Software portfolio, Netease (NTES) added more than 10 percent for the month and has grown to the limit of 25 percent. I had to trim the position to stay within the rules.

In the China fund, I went short on Chinese SOEs again, with ProShares UltraShort FTSE/Xinhua China 25 (FXP). That plus a heavy cash position and defensive holdings kept the month's return to 0.92 percent. Over the past 90 days, the portfolio has paced the market, so last month's under performance notwithstanding, I should be alright as long as I don't sit out the next bull market.