Yuan Freedom Boosts Commodities

Yuan Freedom Boosts Commodities.

When the People's Bank of China said over the weekend that it will move the Chinese currency off of its strict peg to the U.S. dollar, it fueled an upswing of support for commodities Monday as traders laid their bets about what a more richly valued yuan could mean for the market.

The move itself was a long time coming. Under international pressure--mainly from the U.S. and Europe--China made the move but also kept some level of secrecy about exactly when and how it will allow the currency to appreciate. The yuan is moving away from its dollar peg, but buyer beware, warns UBS. "It is important to note that there is not much clarity on just how China's exchange rate policy will change," says Larry Hatheway, an economist at UBS.

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Instead of being a blueprint for action, Hatheway says China's announcement is more a statement of principal and intent. "The focus of exchange-rate policy will be on reference to a basket, not a bilateral exchange rate," Hatheway says. "That means that the dollar-renminbi rate can move in either direction, even if appreciation against the dollar is likely."

The shift away from the dollar peg pushed the long-undervalued yuan to 6.7971 against the dollar on Monday from 6.8272 yuan on Friday. The 0.4% shift may seem small, but it is a strong break from the narrow range around 6.83 yuan to the dollar that had held since mid-2008.

"What all of that tells you is people's perception of where the currency should have been before," says Bob Tull, chief operating officer at Old Mutual Global Index Trackers. "I see this as a good thing across the board for U.S. and European economies. It might slow the importation of Chinese goods as they become more expensive."

The immediate benefit for China will be the easing of political pressure from the U.S. and Europe, which have been unhappy about the yuan being undervalued. Looking further though the move gives better shape to the Chinese economy, Tull argues, as the artificially low currency created inflationary pressure because of the nation's rapid economic growth.

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The announcement pushed commodity prices higher as the rise in the yuan makes commodities priced in other currencies less expensive in China, where demand is voracious. "A firmer yuan and weaker dollar leads to an escalation in commodity prices, and part of that is because now the Chinese inflationary pressure was linked to the dollar," Tull says. "Now that the two are separated, the prices can increase because China can bring in commodities to their economy without feeling inflationary pressure."

Materials and industrial stocks benefited, as the Materials SPDR ( XLB - news - people ) exchange-traded fund increased 0.9%, or 27 cents, to $31.22, while the Industrials SPDR ( XLI - news - people ) ETF gained 0.9%, or 25 cents, to $30.25. Individual stocks like Alcoa ( AA - news - people ) jumped 5.9%, Freeport-McMoRan Copper & Gold ( FCX - news - people ) 3.4%, and Cliffs Natural Resources ( CLF - news - people ) 2.8%.

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