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FxWirePro: CNY gradual depreciation is most likely event in H1 2016 upon commodity impact – stay hedged via 3M forwards

Crude price recovery needs supply glut yet to rebalance: The commodity markets seem to be cautious on price recovery in both base metals and oil to recover through 2016. On the other hand, the underlying forces of the markets are quite diverse.

Crucially, demand is rising and will continue to do so. The oil market still eyes on a rebalancing to correct supply glut, but consequently demand/supply equation is move in sync with pries.

A final drop in prices in response to excess inventories isn't impossible although the storage is abundant, we forecast oil prices towards $60/brl for Brent in Q1 2016.

Base metals and China: On the contrary, base metals were hit by a severe drop in demand from China, which we only presume to be overturned with extreme slowness. The drop in production costs that adds about partially as a result of the fall in base metal exporters' currencies, and the risk of an overshoot to the downside in base metal prices is pretty clear.

We look ahead for steady renminbi deprecation to propel USD/CNY to 6.8 by end-2016, a move of just over 6%. But countries that go from a fixed or managed-peg currency regime to a more free-floating one are at risk of disorderly capital flows and overshoots. An overshoot in USD/CNY to 7.5 on its way to 6.8 isn't likely, but if it happens, we wouldn't be surprised.

Modest USD/CNY appreciation is enough to encourage our Asian FX Strategist, Jason Daw, to recommend short CNH vs DXY, as well as USD/CNH call spreads on a six-month view, and longs in USD/KRW and USD/TWD. If those are attractive trades on a 6% CNY devaluation, they are worth having for the outside risk of a much bigger move.

We still see further weakness in CNY/CNH exchange rate in the foreseeable future.

Hence, it is recommended to buy either 3M USD/CNY forwards of march expiries.

This style of derivative instruments is quite suitable for Small scale international traders as forward contracts does not cost of hedging upfront but provides hedger with a predetermined rate of exchange for certainty.

One can even forgo if prevailing spot FX markets are conducive than forwards rates.

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