Is It Time to Buy Chinese Yuan?

On November 19, the People’s Bank of China ordered the country’s banks to increase their reserves by an additional 0.50%. It’s the second time in two week the Bank has boosted reserve requirements as it tries to keep the value of the yuan down.

But it won’t be enough. The yuan will continue surging despite these latest efforts, creating a tremendous opportunity for anyone who missed out the last time around — even if you’re not a global currency investor.

For one thing, China’s decision to increase reserve requirements it nothing new. Chinese policymakers have used this tool in the past to keep the supply of currency under control. But it hasn’t been very effective. Despite the regulations, the yuan is now 17% stronger against the U.S. dollar. And measures like this are becoming more difficult to implement as the Chinese economy continues to expand.

China’s gross domestic product jumped almost 10% in the third quarter of 2010 — matching the 30-year average. Although dipping slightly from previous years, the current pace of Chinese expansion is 4 times that of the United States.

And the trend is going to continue as long as China maintains its strong exporting relationships. Both the United States and Germany make up about a quarter China’s trade, with South Korea, Hong Kong and Japan comprising another 25%. These countries not only rely on China’s low-cost food processing and manufacturing, they also rely on China’s raw material excavation and energy production. China is ranked third in global energy production and first in wind power.

Domestic demand in China is also going to push the yuan higher. Roughly 200 million individuals are now considered the middle class in China. That figure is expected to more than triple in the next five years as wage growth increases the country’s standard of living.

As it is, consumption of food and electronics has already grown by an average of roughly 30% over the last five years. And the number of Chinese people using the Internet has more than doubled in the past seven. With more and more people joining China’s middle class every day, you can bet that their consumption will continue rising, too.

But you can’t have rapidly accelerating growth without having consumer price increases.

The People’s Bank of China knows this, so it keeps a close eye on the economy’s underlying inflation rate. As the economy keeps booming, China’s central bankers will keep monetary policy restrictive. Simply put, this means interest rates will keep going higher. And higher rates naturally support demand for the currency.

In fact, even though China’s one-year bank deposit rate (currently at 2.25%) doesn’t match the central bank’s national rate of 5.56%, it’s still a bigger draw than the  U.S. savings deposit rates of barely 0.50% The higher interest rate will continue to attract foreign investments and support further appreciation in the exchange rate — no matter how much China tries to control it.

But you don’t need to be a foreign currency trader to participate in the yuan’s unstoppable rise. You can just invest in the WisdomTree Dreyfus Chinese Yuan (CYB) ETF.

CYB aims for returns similar to money market investments available to foreign investors while tracking fluctuations in the Chinese yuan. For everyday investors, it’s a great conduit for slow, stable appreciation in China’s currency. At the same time, it helps diversify domestically focused portfolios without a lot of volatility.

The ETF should do quite well in the months ahead. China’s economy will continue to expand. Central bankers will keep raising interest rates and increasing reserve requirements on national banks. The yuan will continue to appreciate. Ultimately, it’s  an opportunity that’s almost impossible to pass up. And CYP offers a great way to play it.

By Richard Lee

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