Hedge fund’s decade-long wait for China yuan crash nears payday

FOR the better part of a decade, a US hedge-fund manager who has never even set foot in China has been patiently betting that the yuan will stage a massive collapse, one so deep that its value could be cut in half.

Since 2014, Crescat Capital's Kevin Smith has been ploughing as much as 10 per cent of his US$136 million macro fund into options betting against the currency. Sometimes it lost money. Sometimes it paid off, even though the major devaluation he was looking for never happened.

But Smith says now may be his moment.

China's once-booming housing market is cracking. The economy is sputtering under Covid lockdowns. And the People's Bank of China (PBOC) has cut interest rates just as central banks worldwide increase them, giving investors even more incentive to shift money abroad.

Together, those forces have pushed the yuan down by more than 8 per cent against the US dollar this year. That's putting it on course for the biggest annual drop since 1994 - and Smith said it may only be the beginning.

"China is going through a financial crisis today I believe is much more serious than even the global financial crisis in the US," the Denver-based Smith, 58, said in an interview. "For us, the play is in the currency."

Warnings of an imminent Chinese currency collapse are nothing new. Bearish investors for years have been warning that China's banks have lent out far too much money, particularly to finance a real estate frenzy. They've been predicting it will lead to a surge of bad loans so large that Beijing will need to print money to bail out banks, leading to a devaluation of the currency.

The argument is looking timely. China's housing market is faltering, threatening to saddle banks with mountains of non-performing loans. Meanwhile, Beijing's draconian zero-Covid policies have led to rolling lockdowns that are putting China on track for of one of its slowest-growth periods in modern history. In the second quarter, China's economy shrank by 2.6 per cent compared with the previous 3 months, marking the first contraction since early 2020 at the outset of the pandemic.

In response, the PBOC is easing monetary policy, dimming the allure of the yuan by widening the gap between interest rates in China and elsewhere. Foreign investors pulled a record amount of money this year from China's bond market.

Yet Smith is still among the minority. China's large savings, high mortgage down payments and the strong government control of banks mean it is "unlikely to experience a typical debt or financial crisis with uncontrolled credit crunch, large-scale bank failure and substantial depreciation", UBS Group economists led by Wang Tao wrote in a report earlier this month.

In fact, the yuan's decline this year is more of a reflection of a stronger dollar than a weaker Chinese currency as the country's record trade surplus offsets capital outflows. Against a basket of currencies, the yuan has been little changed, and analysts surveyed by Bloomberg expect the yuan to be steady at around 6.9 per dollar by the year's end.  

Smith's conviction on the yuan has never wavered since he started betting against it 8 years ago. China's surprising devaluation in 2015 helped the fund gain 16 per cent that year. Since then, there's been ups and downs, but overall he said the bet has made money.

This year it contributed to the fund's 38 per cent gain through August, along with its bearish bets against large-cap growth stocks and long positions in the energy sector. The gain extended the fund's return since its inception in 2006 to 655 per cent, beating S&P 500's 343 per cent gain, albeit with higher volatility.

"We still haven't seen what we can make on this trade," said Smith. "Maybe it's coming now." BLOOMBERG



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