Shorting the Renminbi; Cross-asset ideas; CSI 300 Flash Crash

Topics discussed:

  1. Can you still hold an Offshore Yuan short position?
  2. Cross-asset ideas – OPEC fails to gain control of oil output
  3. CSI 300 Futures flash crash – a result of HFT?

Equity Indices

  • ASX 200 dropped 1.6% this week, sitting 58.8% above 52w lows;
  • Nikkei 225 dropped 1.1% this week, sitting 28.6% above 52w lows;
  • CSI 300 gained 4.1% this week, sitting 13.4% above 52w lows;
  • Hang Seng gained 4.0% this week, sitting 24.5% above 52 lows;
  • FTSE 100 dropped 1% this week, sitting 51.4% above 52w lows;
  • TSX gained 0.9% this week, sitting 76.6% above 52w lows; and
  • S&P 500 closed at 2,099 this week, sitting 90.3% above 52w lows.

FICC

Bonds: headline risk-free rates (those commonly used in WACC calculations) continue to charter new waters and thus it’s left to bankers to be creative in which risk-free rates are chosen.

If yields continue to compress towards a lower bound, will interest rate policies reinvigorate a renewed reference rate?

  • German 10-year closed at 0.106%, down 23% this week;
  • UK 10-year closed at 1.342%, down 6% this week
  • US 10-year closed at 1.798%, down 3% this week

Headline risk-free rates.PNGNote: yield moves inverse to price, whereby higher perceived risk in equity markets tend to translate into lower government bond yields.

Commodities: oil and metals generally experienced a mixed week of trading:

  • Brent and WTI closed at $50.08 and 49.17 per barrel, up 0.3% and down 0.6% respectively, as oil futures recovered early week losses post-OPEC meeting;
  • Gold stood at $1,211.68/oz, trading within the boundary of $1,200/oz in the last year;
  • Silver stood at 16.064/oz, below last week’s peak of $17.847/oz; and
  • Copper stood at $209.95/lb, sitting near a one year low.

Topic 1: Shorting the Yuan, are you crazy?

  • The Yuan closed at 6.5872/$, depreciating to near its weakest point in over a year as the PBoC looks to accompany currency depreciation with monetary policy stimulus.

6-year historical of Yuan.PNG

China’s economic growth has become the proxy for global demand appetite, so much that the increasing debt load China carries forward as its economic growth falters becomes a greater concern for global equity markets.

PBoC stimulus.PNG

The risk of capital flight from China, as a result of Fed going on its hike, is a material as concerns over China’s FX reserve position persists.

The US has become less vocal about the depreciating Yuan in recent months, perhaps more concerned on whether they will have a credible presidential candidate to elect… Nonetheless, the Yuan’s position against the USD will need observation as a higher Funds Rate will undoubtedly attract greater institutional capital as earnings and return on capital rise.

Money supply vs. GDP.PNG

On the other hand, we have George Soros. While it is not difficult to become ‘famous’ in the investing world, it is much more difficult to become respected and listened to.

Soros has been public about his short position on Asian currencies as China’s debt pile and faltering economy is not as high-growth of a prospect as a decade ago. When you go up against sovereign nations, as Paul Singer of Elliot Management does, you’d better make sure your war chest is just as big as the nation which you are going against.

In the case of Soros, Soros Fund is up against the second largest economy in the world – an economy with over $3 trillion in FX reserves stored up and a control over the interest rate charged on investors holding offshore Yuan positions.

CNY vs. CNH differential

The graph above shows that as the onshore vs. offshore spread narrows, so does the arbitrage opportunity in a short position.

Topic 2: Cross-Asset Ideas

The greatest investment advice I have received on cross-asset trades has been to run a phantom portfolio on the positions you wish to trade – correlations occur in all manners but the timing of entry and exit is much more important as price swings can occur in both directions.

Thursday’s OPEC meeting reiterated one thing: you can’t control how much petroleum we pump out of the ground, regardless of whether we elect a new secretary general.

USCRWTIC Index (Bloomberg West T 2016-06-03 16-23-52

OPEC Secretary General or not, the petroleum organization has yet to make progress to influence the direction of oil futures – the current price reflects a lack of ‘finiteness’ in the natural resource.

TTM retracement of WTI

USCRWTIC Index (Bloomberg West T 2016-06-03 16-24-49.jpg

Idea 1: Gold spot vs. USD/EUR

USDEUR Curncy (USD-EUR X-RATE) 2016-06-03 17-55-12.jpg

Idea 2: WTI vs. (inverse) Dollar spot

USCRWTIC Index (Bloomberg West T 2016-06-03 17-49-24.jpg

Idea 3: WTI vs. USD/EUR

USCRWTIC Index (Bloomberg West T 2016-06-03 17-54-04

These are USD-based cross-asset ideas.

Topic 3: CSI 300 Futures Flash Crash

IFBM6 Index (CSI 300 Futures) 1 2016-06-03 11-25-58

CSI 300 futures index {IFBM6} <GO> dropped 12.61% instantly at 10:42 before jumping back to within 10% of its previously traded level:

IFBM6 Index (CSI 300 Futures) 1 2016-06-03 11-22-36

Data compiled by Bloomberg suggest that 398 contracts were executed and consecutively filled at current market prices – this supposedly causing the index to drop from >3,100 to <2,750, according to the China Financial Futures Exchange. That equates to a c.12% instant drop…

This is perhaps a convenient time for the HKEx to introduce its Volatility Control Mechanism, a tool designed to,

prevent extreme price volatility from trading incidents such as a “flash crash” and algorithmic errors… if the price deviates more than a predefined percentage within a specific time frame, it will trigger a cooling-off period, according to HKEx.

On the other side of the equation, the flash crash shows that development of financial markets in Hong Kong and China are in fact progressing – the crash almost undoubtedly caused by HFT – and is a sign fintech becoming prevalent within the futures markets. However, widespread progression is yet to be seen, as Hong Kong continues to lag way behind advanced economy peers.

The ratio of IPO vs. back-door listings continues to be highly skewed towards the latter, as SFC chairman Carlson Tong recently discussed the issue of shell planting during the SFC Forum, whereby a prospective issuer is going public in the hopes of being reverse takeover’d by a larger enterprise and cashing the shell premium, which stands at HK$400-700 million (discussed previously here).

Back-door listings as a means of money laundering is explained in a nut-shell by Tom Holland of the Hong Kong Free Press,

A Chinese entrepreneur may set up an offshore shell company to hold the stake he owns in his mainland business. He then floats the business on the Hong Kong stock exchange, booking the proceeds of the offering in an offshore tax haven. Either way, the cash can then be routed back into China—either directly or through Hong Kong—labelled as foreign investment, which allows the beneficial owner to collect powerful tax benefits.

The amounts involved are enormous. In 2014, the latest year for which the Hong Kong government has published data, the city channelled direct investments worth HK$637.9 billion into the mainland. Most of that money came not from Hong Kong investors, but from anonymous shell companies in offshore financial centres. By far the biggest source was the BVI, which according to government figures channelled HK$476.7 billion into Hong Kong.

So when Hong Kong government officials insist that the city is not a money laundering centre, they are being something less than wholly honest. They know full well that those hundreds of billions of dollars consist largely of disguised mainland funds which only acquired their glowing sheen of legitimacy by being round-tripped through the combined laundry of secretive offshore financial centres and Hong Kong’s financial system.

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