Goldman and Nomura Rate Yuan Forwards as Asia’s Most Profitable Bet in 2011

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Dec. 17 – As the Chinese government shows more determination to curb domestic inflation and still faces accusations of an undervalued yuan, a majority of financial institutions forecast faster appreciation of the yuan next year. Goldman Sachs and Nomura recently said yuan forwards will become the best way of making a profit in Asia’s foreign-exchange market in 2011.

Goldman Sachs, the world’s leading investment banking and securities firm, advises investors buy two-year non-deliverable forward contracts on the yuan, commenting that the yuan is the currency that is most likely to keep advancing in the Asian market if Europe’s debt crisis creates more demand for U.S. dollars and makes it harder for other Asian currencies to gain. Nomura Holdings, Japan’s largest investment bank, recommends three-month forwards, forecasting the yuan to see a faster appreciation before China’s President Hu Jintao’s scheduled visit to the United States in January.

The U.S. government has long been accusing China of using the undervalued yuan to benefit domestic exporters. U.S. President Barack Obama said on November 12 that the yuan was “undervalued” and calls for more progress on the issue. The U.S. House of Representatives has also passed a law that would make it easier for U.S. companies to petition for higher duties on Chinese imports.

Chinese Vice Premier Wang Qishan recently discussed currency issues with U.S. Treasury Secretary Timothy Geithner in Washington, after some U.S. senators sent a letter to Wang urging the yuan to be allowed “to appreciate meaningfully” before Hu’s visit to Washington.

On China’s Annual Central Economic Work Conference that just closed on December 13, the country stressed stabilizing prices while vowing to maintain the rapid pace of its economic growth. China has also recently announced a shift to a prudent monetary policy.

The Chinese yuan experienced a period of salient appreciation after a currency peg ended in July 2005, and saw a 21 percent increase over the following three years. After the People’s Bank of China’s pledge to allow greater exchange-rate flexibility in June this year, the yuan has again risen 2.5 percent against the U.S. dollar after halting appreciation for two years during the global financial crisis.

Most economists and financial institutions expect the yuan to reach a higher value at the end of next year. A Bloomberg survey based on the median estimates of 20 analysts predicts the yuan to increase 6.1 percent to 6.28 percent by the end of 2011. Michael Buchanan, chief Asia-Pacific economist at Goldman Sachs in Hong Kong,  forecasts a 5.9 percent advance to 6.29 yuan per U.S. dollar by the end of next year, and another 7 percent gain in 2012. An Asia foreign-exchange strategist Craig Chan at Nomura in Singapore expects the main appreciation to happen during the first quarter, when the meeting between Hu and Obama happens.

On the other hand, some specialists doubt if yuan forwards are really as profitable as people think they will be, considering the interest costs. Nizam Idris, a currency strategist at UBS AG, Switzerland’s biggest bank, told Bloomberg that it is wrong to think of yuan forwards as a one-way trade only and ignore the possibility that the long-term costs of trade will offset the gains.

Miza Baig, a currency strategist at Deutsche Bank recommends investors to buy the yuan with 12-month deliverable contracts in Hong Kong’s offshore market since the “offshore yuan deliverable forwards are currently the cheapest way to access the yuan.”

Baig also suggests “buying the yuan versus a basket against the U.S. dollar, euro and yen.”