As the Chinese stock market takes its pratfalls many investors wish they could trade Chinese stocks in that market. Some would wait for the market to bottom out in order to buy and others would swing trade in search of profits as the market falls, rises and falls again. However, the vast majority of Westerners cannot trade in the Shanghai stock exchange or the smaller Shenzhen stock exchange. In fact, most would not want to because of tight capital controls, manipulation by the central government and the casino-like approach of many mom and pop Chinese investors. But, tapping into Chinese volatility could lead to profits. With alternative approaches in mind, are the South Korean won and the South Korean economy good surrogates for betting against China?
The Won as a Surrogate
Bloomberg Business reports that hedge funds are selling the Korean Won as a surrogate for betting against China.
Hedge funds and other large speculators turned bullish on the Australian dollar last week for the first time since May 2015, while Macquarie Bank Ltd. said selling South Korea’s won is now the favored way to bet against China.
South Korea’s won has been February’s worst-performing major currency amid rising geopolitical risk from North Korea and speculation the central bank will cut interest rates. Bank of Korea Governor Lee Ju Yeol said last week that economic uncertainties are “higher than ever.”
The correlation between the won and yuan are higher than for other emerging-market currencies in Asia and the markets “clearly” see the Korean currency as a good proxy for the short China trade, wrote Jonathan Cavenagh, head of Asia emerging-market currency strategy at JPMorgan Chase in Singapore.
China is Korea’s third largest trading partner at well over $200 billion a year. As Chinese imports and exports fall, this affects South Korea’s economy. As the Yuan falls so does the Won as the highest correlated currency to the Yuan in Asia. The Won trades freely on international market unlike the Yuan which is still subject to Chinese Central bank controls.
Are There Confounding Factors?
Although the Won seems to move in lockstep with the Yuan and Korea’s economy is strongly linked to that of China there is another major factor in this case. North and South Korea are still at war! The USA has troops stationed in South Korea and routinely engages in exercises with South Korean forces in preparation for a potential renewal of hostilities. Reuters reports on North Korea’s warnings regarding military exercises in the south.
North Korea warned on Tuesday of harsh retaliation against South Korea and its ally the United States, which are preparing for annual joint military exercises next month amid heightened tensions following the North’s nuclear test and rocket launch.
This area is still a potential powder keg sixty-three years after cessation of hostilities in the Korean War. To the extent that North Korea does something really dumb like attacking the South all bets are off regarding Korea’s economy and currency closely tracking that of China.