Impact of Yuan Revaluation on Commodities

Beijing faces international pressure to scrap the yuan's peg, especially from Washington, which says the currency is seriously undervalued, sparking reports China may be about to revalue the yuan. While the size of revaluation is still being debated (2-5% cited initially) the impact is likely to be positive for commodity prices, particularly those where China is both a large, high-cost producer and a significant consumer. More importantly, it will serve to increase China's reliance on imports by reducing the cost (in RMB) of those commodities where it is a significant net importer. Raising the value of the yuan versus other currencies would cut the cost of China's imports of dollar-denominated commodities such as oil, copper and iron ore, while making Chinese exports more expensive. The greatest impact will probably be seen in bulk commodities such as iron ore, metals such as copper and in soy, where China is a big importer and consumes most of the products made from those imports at home.
China % of world consumption & seaborne production 2010E
Source: JP Morgan
Allowing the yuan to resume appreciation may help China control inflation amid record lending growth and surging property prices. The exchange rate has been kept at about 6.83 per dollar since July 2008 to help Chinese exporters wither the global recession.

Even a rise of 3 percent in the value of the yuan, the range of increase discussed, to around 6.60 to the dollar from last year's average, would have a profound effect on China's $244 billion commodity bill. Last year the country spent around 607 billion yuan ($88.97 billion) on importing oil, 343 billion yuan ($50.28 billion) on iron ore and 206 billion yuan ($30.20 billion) on copper. An increase of 3 percent in the yuan would have saved the nation some 56 billion yuan ($8.21 billion) on its commodity purchases, or enough to buy more than 1 million tonnes of copper.

The last time China raised exchange rates back in 2005, commodities saw a steady rally for more than a year after the revaluation. At that time copper prices doubled to a then record high of $8,800 a tonne in 2006, chipping around half a million tonnes off copper consumption annually.

Source: Bloomberg
The above chart shows the CRB Index, which tracks 19 commodities, the yuan exchange rate in the spot market and 12-month non-deliverable forwards for the currency. The CRB index surged about 10 percent in the first six weeks after China ended its decade-long peg of about 8.3 per dollar in July 2005, and that could be repeated.