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China Diversifying Out of U.S. Dollar Holdings

Stock-Markets / Investing 2010 Jul 14, 2010 - 08:02 AM GMT

By: Tony_Sagami

Stock-Markets

Best Financial Markets Analysis ArticleEvery month, the world buys BILLIONS of dollars worth of toys, shoes, electronics, clothes, and consumer goods from China.

Every month, China enjoys a trade surplus that brings in BILLIONS of new dollars into its coffers.


And every month, China has to decide what to do with those BILLIONS of new dollars.

For years, China has used those BILLIONS to buy U.S. government bonds and is now sitting on $900 billion worth of our debt and is the U.S.’s largest creditor. Japan, by the way, is the second largest owner of U.S. government bonds.

China is re-thinking that wisdom. In the month of May (most recent data), China purchased a record $8.3 billion worth of Japanese government bonds.

To put that number in perspective, China previously bought $6.1 billion worth of Japanese bonds in the first four months of 2010. In just one month, China QUADRUPPLED its allocation to Japanese bonds.

And it is a complete turnaround from the $900 million of Japanese bonds that it SOLD in 2009.

There are several important implications to this move that could help you both avoid some investment pain, as well as make you some serious money.

MONKEY SEE, MONKEY DO #1: Damned (Japan) by Faint Praise. $8.3 billion is a gigantic amount of money, but don’t take China’s purchase as a signal to buy Japanese bonds. The vast majority of that $8.3 billion went into short-term bonds, which tells me that China was looking for a temporary parking spot instead of making a commitment to the Japanese bond market. If China was positive on the long-term outlook for the Japanese bond market, it would be buying 10- or 20- or 30-year bonds instead of 90-day notes.

James Bond had a way with the ladies and the Japanese treasury department is telling men that buying Japanese bonds will improve their love life!

The Japanese government has launched a national advertising campaign to promote ownership of Japanese government bonds or JGBs. According to the ads, women prefer men who invest in government debt because they are sensible investors. The ad shows five women who say they would choose husbands who are “serious about money” and invest for “stability.”

“Women have a thing for men who own JGBs!! Right!?”

A five-year Japanese bond only yields about 0.4%, so a little sex appeal will help!

MONKEY SEE, MONKEY DO #2: Damned (U.S.A) by Omission. The most important message behind this move is the clear, unequivocal message that China has lost faith in the U.S. dollar. Many if not most of those monies that went into Japanese bonds had historically been invested into U.S. bonds, so China is actively diversifying itself out of dollar-denominated holdings. With the way that our elected officials are spending money, do you really blame China?

As Chinese Premier Wen Jiabao put it, “To be honest, I am definitely a little worried. We have loaned huge amounts of money to the United States, so of course, we have to be concerned. We hope the United States honors its word and ensures the safety of Chinese assets.”

Chinese Premier Wen Jiabao has expressed concern over huge amounts of American debt his country owns.
Chinese Premier Wen Jiabao has expressed concern over huge amounts of American debt his country owns.

In the past, Chinese authorities have hinted that they might “drop the nuclear bomb” and drastically reduce its U.S. bonds.

MONKEY SEE, MONKEY DO #3: Praised (Gold) by Faint Damns. If China is lukewarm on Japanese bonds and downright pessimistic about U.S. bonds, what are they going to do with all those billions that come into its coffers each month?

The Chinese State Administration of Foreign Exchange, which manages China’s $2.4 trillion reserve, said:

“Gold is globally recognized as a store of value and can be used for urgent payment, but … it cannot become a main channel for investing our foreign exchange reserves.

“Even if we double the amount, it can only diversify about $30-40 billion of China’s foreign exchange reserves.

“We will take careful consideration of our demand and the market situation when reducing or increasing our gold reserves.”

China has already increased its gold reserve by more than 400 tons over the last couple years to 1,054 tons and is clearly going to buy more.

China has been loading up on gold to help diversify its foreign exchange reserves.
China has been loading up on gold to help diversify its foreign exchange reserves.

There are some pretty darn good pieces of investment advice there and a little monkey see, monkey do would be a very smart move. Specifically, you should consider:

Contra-Dollar Assets. I don’t mean to sound like a broken record, but things like the Merk Hard Currency (MERKX) mutual fund and the WisdomTree Dreyfus China Yuan (CYB) exchange traded fund should do well.

Anti-Dollar Assets. If you’re more aggressive and wanted to bet directly against the U.S. dollar, take a look at PowerShares DB U.S. Dollar Bearish (UDN) exchange traded fund, which is designed to profit from a falling dollar.

Shiny and Yellow Assets. If you want to own some gold like the Chinese, the SPDR Gold (GLD), an exchange traded fund that owns more gold than Fort Knox, or U.S. Global Gold and Precious Metals (USERX) mutual fund are two excellent choices.

Anything But Assets. The bigger picture is to move a significant portion of your monies into assets that are not priced in U.S. dollars. I’m talking about overweighting your portfolio with foreign bonds and foreign stocks. For example:

  • If you want to own an auto stock, I believe you’ll do better with Toyota (TM) than Ford (F).
  • If you want to own a computer stock, I think you’ll do better with Lenovo (LNVGF.PK) than Dell (DELL).
  • If you want to own an oil stock, I think you’ll do better with China National Offshore Oil Corporation (CEO), than ExxonMobil (XOM).
  • If you want to own a drug stock, I think you’ll do better with Lotus Pharmaceutical (LTUS.OB) than Pfizer (PFE).

Now, I’m not suggesting that you buy any of the above listed stocks tomorrow morning. What I am attempting to show you is how easy it is to reduce the dollar risk to your portfolio by simply investing in similar but foreign competitors.

By the way, each of those above listed foreign stocks is available on a U.S. stock exchange, so you don’t need a fancy foreign brokerage account to invest in them.

It is just as easy and cheap to buy shares of China Mobile (CHL) as Verizon (VZ) or to buy Bidu.com (BIDU) or Google (GOOG).

I wish I could, but I cannot tell you WHEN the U.S. dollar is going to tank. But I can tell you with great confidence that it WILL tank and take your portfolio with it if it is overloaded with dollar-based stocks and bonds.

Best wishes,

Tony

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