No matter how often economists illustrate that there is no clear causality between the value of the yuan and the US economy, both Democrats and Republicans on Capitol Hill are again displaying their anger over China's exchange rate policy. Revalue it to their liking ... or else. But this should come as no surprise with midterm elections for both the US Congress and Senate approaching.

However, the renminbi has been rising since the middle of June this year. But the US Congress is still very unhappy about the pace and it is widely expected that the yuan's "appreciation" will last for a protracted period amid the wrangling between China and the US.

China's trade surpluses and political pressure from abroad are both growing. In addition, domestic consumption on the mainland has regained its momentum, easing officials' concerns over allowing faster yuan gains. Thus we believe that minor political disputes between China and its trading partners and currency intervention by the Japanese government will not be significant enough to reverse the course of further yuan appreciation.

However, in order to capture the investment opportunities of yuan appreciation, we need to identify which markets will benefit most from it.

The most obvious beneficiaries are those countries in which China's imports play an important role. Australia should benefit most. With China being Australia's largest export market, and taking up to a fifth of the latter's exports, every indicator of economic strength in China would be mirrored in the Australian dollar and stock market. The shock on the Australian equity market from the slowdown of the China purchasing managers index - an indicator of economic activity - in the second quarter this year has already demonstrated how closely co-related they are. Coal and iron ore are the main export commodities in Australia and these are the most wanted natural resources in China. Therefore, a tandem advance of the yuan and the Australian markets seems like a corollary. South Korea's electronics industry would also benefit. However, this is not as strategically important as raw materials.

Traditionally, emerging markets usually see a positive correlation between their currencies and equity markets, since the latter is one of the ways of utilizing an appreciating currency. Capital inflows will further push up the foreign exchange rate and create a virtuous cycle. However, unlike other emerging markets, China's currency does not have a strong correlation with the domestic equity market. This is mainly because the domestic A-share market is closed to foreign investors. And more importantly, directive Central Government polices are crucial. So, from this perspective, the A-share market could not be a proxy to ride the tide of yuan appreciation.

Would gold then benefit from a rising yuan? The answer is: "Not applicable." There is a long cherished hope that emerging markets, such as China, will buy more gold to form part of their holdings in foreign reserves. However, official data has indicated that this will not happen as quickly as investors expect. At 1.8 percent, gold is a very small part of China's foreign reserves and is far below the international average of 10.2 percent. A rising yuan may grant a discount on gold, which is commonly priced in US dollars. However, it is not a significant reason for the Chinese government to accumulate gold since the move of foreign exchange reserves are largely attributed to political discretion rather than economic reason.

A rising yuan would also means stronger domestic purchasing power. To seize this opportunity, we may think about proxies that would benefit from the improvement in Chinese purchasing power. But the A-share market may not be one of them due to regulatory restrictions.

The author is a research manager at Alroy Financial Services Ltd, an independent financial services provider. The opinions expressed here are entirely his own.

(HK Edition 09/22/2010 page2)