China May Add Fuel To Commodity Rally
By Win Thin
The press is reporting that China plans to set up new investment funds that will put some of its $3 trln in foreign reserves to work in energy and precious metals. The PBOC is also reportedly studying a proposal to set up some sort of currency fund that would help stabilize the yuan exchange rate. No further details were given on either plan in terms of size or timing. The story comes on the heels of official comments last week suggesting unhappiness with the size of its foreign reserve holdings. As we noted, PBOC advisor Xia said China only needs $1 trln of foreign reserves and that the rest should be used to accelerate strategic investments. This is a bit different from PBOC Governor Zhou’s remarks, who simply said foreign reserves have exceeded a "reasonable" level, and that the management and diversification of holdings should be improved as “the build-up could cause big risks."
We believe that until CNY is allowed to float freely, PBOC will always be facing inflows of USD that is must mop up. Even a big one off revaluation is unlikely to turn away the money that is flowing into China, both from trade surpluses and investment inflows. China is unlikely to shift from being a significant buyer of USTs no matter the shift in FX policy, but these latest comments suggest further diversification at the margin away from dollar assets into hard assets. This will only add to upward pressure on the commodity complex, and critics of Fed policy will likely seize on this as another unwanted by-product of current US monetary policy.
Xia walked back his comment today about a one-off revaluation supports our view that such an aggressive policy move is unlikely. However, we do think that faster appreciation could be seen in the coming weeks, today’s CNY weakness notwithstanding. Indeed, today’s spike in USD/CNY appears to have been a big short-covering move after Xia’s comments, as markets are almost universally short USD/CNY on expectations of a stronger currency being allowed to fight inflation. We do think yuan gains will resume and continue, and that the actual y/y pace could move closer to 10% from 4.5% currently.