Taleb-Style Trade Idea: Long CNY

While I'm certainly not the originator of this trade idea, I find it very interesting for a longer-term play. It is a trade with low downside risk and out-sized upside gain potential. The idea is long the Chinese Yuan through the Van Eck Market Vectors-Chinese Renminbi/USD ETN (NYSE:CNY). The primary risk in this trade is the opportunity cost of capital should revaluation not occur in the near future. Yet, exposure to the possible right tail payoff could be well worth it.

China is currently struggling to fight inflationary pressures much of which are driven by an artificially low managed floating exchange rate against other currencies. For decades the renminbi was pegged to the dollar at various rates used to achieve economic goals. From 1997 to 2005, the renminbi was pegged at $1:¥8.27. The $:¥ is currently at ¥6.8272 and is managed by the People's Bank of China (PBOC) to remain within a 0.5% band around parity against a basket of currencies as determined by the PBOC. The International Monetary Fund estimated purchasing power parity (PPP) in 2008 was ¥3.798 whereas the renminbi averaged a value of ¥6.9451 throughout that year. This implies that 2008 rates were a 45% discount to PPP. The shift from a peg to a managed floating rate has gradually allowed the yuan to appreciate up to current levels but a significant under-valuation remains.

Pressure on China's central bank to revalue the remnimbi continues to build from both internal and external forces. China is well aware that in order to become a leading global economic power it will need to transition to a floating rate regime. Externally, the US has threatened to label China a currency manipulator while European counties have likewise voiced their complaints. April 30th readings on inflation showed consumer prices increasing 2.8%, producer prices jumping 6.8% and property prices rising a staggering 12.8% year-over-year. Retail sales rose 18.5% for the month. These data points show that even with the debt woes in Europe, the PBOC may have to further tighten monetary policy. Part of the policy could very well include a re-valuation of the yuan.

This trade idea is modeled after the Nassim Nicholas Taleb concept where rather than striving for the consistent, high probability gains while exposing yourself to the black swan left tail event, look for circumstances that offer a skewed risk/reward structure where the mean return is relatively low, there is virtually no left tail risk yet there is exposure to a large right tail profit potential.

Disclosure: No position currently.

Best Employment Report in 3 Years

The US economy added 162,000 jobs in the month of March and the unemployment rate held steady at 9.7%. Yay! This is the best report we have seen since pre-crash March 2007. Yes, 48,000 jobs were temporary consensus hires but I'll take it! I realize it's marginal but it's better than nothing, glad to see some people getting back to work. Bonds took a hit with 30-year Treasuries right back to support after bouncing earlier this week and S&P futures are trading at new highs for the year.

The banter between the US and China continues with the US Treasury report on the yuan currency coming out in just two weeks. Pressure is heating up to call China a "currency manipulator" in the report. It seems to me the attempt is to blackmail China into revaluing its peg higher against the dollar. But, if China gives in wouldn't that prove more than anything that China is a "currency manipulator"? The People's Bank of China is understandably hesitant as it worries about inflation and a possible drop in exports.

I've still got my swing longs in WFMI, LVS and NKE and short in TLT so this jobs report Friday and subsequent reaction so far is helping me out. All positions are just initial entries and I have areas to add that very possibly trigger on Monday.

All right, enough thoughts about the market, time to take advantage of this long weekend and knock out some serious CFA studying.

Day Off for Americans, China May Revalue Yuan

Tokyo fell 79 points to 10,013 (0.78%) while is London gained 25 points (0.49%). New York is closed for President's Day.

The markets are waiting on clarity from European leaders as plans for Greece unfold this week. So far, EU leaders have pledged support for Greece in return for Greece taking steps to reduce its record deficits. Any wavering this week on the commitment to Greece could spell further downside for the euro. The euro has now retraced 60% of the 9-month move from March 2009 lows that took the euro from $1.25 to a high of $1.51 in early December. In just the last two and half months, the euro has dropped rapidly now trading at $1.36 as the EU struggles with the burgeoning sovereign debts of the so-called PIIGS (Portugal, Italy, Ireland, Greece & Spain).

Rumors abound that China may revalue the yuan very soon in order to cool down its overheating economy. Goldman Sachs Chief Economist, Jim O’Neill, told Bloomberg News Friday that he thinks Beijing may be ready to allow the yuan to rise by as much as 5% in a one-time revaluation. This would make sense politically and economically for China and would be significant boon to Western economies, specifically Europe which receives double the blow as the dollar falls and the yuan falls with it.