China's Currency Moves Suggest Some Kind of Deal

As many RealMoney readers who have corresponded with me over the years can attest, I hate conspiracy theories. They are fun, to be sure, but they violate the famous principle of Occam's razor: The simplest explanation is the best explanation.

Every goofball hedge-fund trader who hears a tidbit from a "disinterested" broker or counterparty falls into the trap of thinking that he or she has the inside scoop on something. No, someone just had to buy or sell for whatever reason, and in a combination of the Hindu parable of the Six Blind Men and the Elephant and the childhood game of telephone, some generally worthless information regarding a tiny part of the puzzle is circulated endlessly and takes on great meaning.

But what if a backroom deal is the simplest explanation? Let's take the Chinese yuan. I demonstrated this past January how the yuan and the total return of the S&P 500 were negatively correlated over the vast majority of the post-July 2005 period when the good people of the People's Republic permitted the yuan's gradual and very managed revaluation. Regardless of whether U.S. stocks rose or fell, the rolling three-month correlation of returns generally was negative.

But starting on the very day of the Fannie Mae (FNM - commentary - Cramer's Take) and Freddie Mac (FRE - commentary - Cramer's Take) backstopping, July 14, 2008, marked on all of the charts with a green vertical line, the yuan ceased its rise against the dollar and entered into a trading range. And the very negative correlation of returns between the yuan and the S&P 500 turned higher and ended last week at its highest point ever. "Ever," just to clarify, is a long time.

The Yuan and U.S. Stocks Now at Peak of Positive Correlation

Click here for larger image.

Source: Raw data from Bloomberg

Now let's take a look at another exchange rate, that of the yuan against the euro. As the yuan flatlined against the greenback, it took off like a scared rabbit against the euro; it has appreciated about 8.5% against the common currency in less than two months.

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Howard L. Simons is president of Simons Research, a strategist for Bianco Research, a trading consultant and the author of The Dynamic Option Selection System. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. While Simons cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.

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