Monday, June 22, 2015

Mexico - peso to rebound in value?

The Mexican peso (MXN) has been quietly but steadily depreciating in value in relation to the
 US-dollar (USD) for the last several years. In May 2011, the peso traded at 11.65 MXN to the USD. By June 2014, it further declined to 13 MXN. Over the last 12 months, a further 15 percent drop in value for the peso to the 15.3 MXN range reflecting a recent trading day quote on June 22, 2015.

Why the drop? In our view, this has more to do with a very strong USD over the last year year coupled with  a dramatic decline in the world oil price. As Mexico is a large oil producer, it is implementing policies to modernize and allow for foreign investment into the industry to help foster increased hydrocarbon production going forward.

Mexico today is doing quite well on many macro economic measures including low inflation at 3%, low Central Bank interest rates at 3%, growing exports and diversification of the economy. In fact, Mexico today is one of the world's largest exporters of electronic goods - primarily to the United States. Other major industries include auto production, now the largest producer in North America. The national oil industry is spearheaded by state owned Pemex. Tourism, telecommunications, transportation, mining and agriculture also are large contributors to overall GDP.

Some analysts have Mexico pegged to be one of the world's largest economies by year 2050 in a club with China, United States, India, Brazil, Germany, United Kingdom, Russia, Nigeria, Indonesia and France. How so? Mexico has had significant and steady population growth for over 50 years now. Recent estimates have the national population of Mexico at 120 million. The other country of significance similar to Mexico with skyrocketing population growth is Nigeria.

As measured by purchasing power parity, the MXN is currently 50% undervalued to the USD. The MXN is one currency to keep your eye on for a potential rebound in currency price valuation. Although historical risks remain such as episodes of high inflation's. political instability and currency devaluations, it is likely Mexico has now entered a new era of relative currency stability.

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Monday, March 23, 2015

Hong Kong USD peg and China Crawling USD peg

In time, most currency pegs and currency board arrangements for well advanced developed economies ultimately dissolve. For China, they are now the second largest economy in the world only behind the United States. Of interest, is that the Chinese yuan follows a managed crawling peg to the US-dollar (USD) with a current trading value of 6.2 CNY to the USD. Five years ago, this trading value was at 6.82 CNY, so the Chinese yuan has modestly appreciated to the USD during this time.

Conversely, Hong Kong dollar (HKD) has a thin trading band currency peg to the USD in a trading range of 7.75 to 7.85 HKD to the USD. The implications for a currency board arrangement for Hong Kong is that it has imported America's low interest rate structure thus resulting in sky high real estate valuations in Hong Kong.

Currency policy can have significant impact on a great number of people in the world today. Only have to look at Greece and Venezuela, case in point.

Misguided currency policy can contribute immensely to Hong Kong's very expensive real estate which which has priced a great number of citizens out of the market. The social implications are tremendous as it has resulted in protests as the world has noticed over the last couple of years with thousands of Hong Kong residents participating in the 'umbrella' sit it.

What's next for both Hong Kong and China's currency?

Purchasing power parity suggests the Chinese currency is approximately 40 percent undervalued to the USD whilst the Hong Kong dollar is 50 percent undervalued. A revaluation of the currencies is imminent but when?

Our best educated guess is likely somewhere in the year 2017 time frame when the Chinese yuan / renminbi currency becomes fully convertible - projected time line. At this time, Hong Kong would be more inclined to give up its USD peg and either re-peg to CNY or perhaps freely float the HKD.

With significant increased capital flows and trade between Hong Kong and China, it is inevitable the USD peg is near the near the end of its story, particularly for Hong Kong with its 32 year love affair with American money.

Saturday, January 17, 2015

Swiss Short-Term Currency Traders Offside

The recent removal of the Swiss franc (CHF) currency peg to euro by the Swiss National Bank caught many short term currency traders by surprise. Long term, our view remains unchanged as we believe the CHF will ultimate decline in value relative to the USD. Today, the CHF is currently 64% overvalued to the USD as measured by purchasing power parity.

Lesson learned in major currencies like the Swiss franc and currency pegs. Surprise currency interventions and policy changes can work against your trade in the very short term with extreme currency valuations as traders cover their shorts (those betting on a short term decline of the franc to the USD and the EUR). If you are a long term trader, purchasing power parity is a good measure to determine a currency value.

In the unique case of Switzerland, their is an inherent premium built into the  CHF value due to its historical lure as a safe haven currency. Further, currencies can remain in an overshoot or undershoot position much longer then most traders can stay solvent. If we assume a built in 25% purchasing power parity premium to the price of the CHF, then over the long term, their is a high probability that the CHF will ultimately decline relative to the USD back towards a 80 to 85 cent US fair value. If the currency undershoots, then 65 US to 70 US cents is possible. This could take years to achieve.

In the world of currencies, irrational market behaviour and illogical valuation can last for a very long time as perception / emotion and safe haven status premiums can artificially support an expensive currency valuation.

We prefer to take medium to long term positions rather then roll the dice in short-term currency moves thus mitigating risk from unforeseen policy decisions that can move a currency into a further illogical trading value.

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