Shorting Russia Via Ruble ETF Trade

A bet on the future shape of an emerging market economy can be made, with an acceptable degree of precision, by fluctuations in currency rates. In addition, the near-term fate of certain developing-world currencies is relying heavily on movements in commodity and energy prices. The latest Rydex Russian Ruble ETF (XRU) provides compelling solutions for investors who desire to establish Russia-specific trades based on, or driven by, the two propositions.

Without doubt, the entire foreign exchange matrix has been enhanced by the introduction of currency ETFs. And this writer recommends that investors should ignore mutual funds dedicated to the rather onerous task of trying to pick winners in a recessionary environment and focus only on basic, fundamental bets on the direction of emerging markets in 2009.

The Rydex Ruble ETF (XRU) is a significant addition to the currency trading spectrum, which already includes futures (CME) and non-deliverable foreign-exchange forwards offered by ICAP [IAP.L] and other market-makers, since it offers monthly returns on long-Ruble positions. For many years now, retail and institutional investors, and arbitrage traders, have been seeking efficient mechanisms to access the high-interest rate environment in emerging economies like Russia, Mexico, India, Turkey and Brazil; the Ruble ETF is a good start in the right direction. The yield criterion (15% and above on current indications) also enables a series of attractive pair trades involving oil and gas, depending on how investors view the correlation risks involved. (Jonathan Liss, on November 16, 2008, provided an informative summary; visit the Rydex Investments website for more on currency ETFs).

Arbitrage and pair trading apart, the Ruble ETF offers a relatively precise play on Russia. In technical terms, the Ruble can be priced synthetically on the back of a basket (currently 55% dollars, 45% euros). Regardless of a spate of Russian central bank interventions, this writer is short Rubles via non-deliverable forward contracts, and fully intends to extend that short position via the Ruble ETF. This writer regards CDS spreads on Russia as a more definitive signal of inherent Russian sovereign and corporate risks than any other comparative benchmark. Five-year CDS spreads for Russian sovereigns were being quoted between 1,100 and 1,250 basis points on Tuesday.

The reasoning is fairly straightforward: despite periods when the gap between the dollar/Ruble rate (or the euro/Ruble rate for that matter) on one hand and key Russian economic and financial markets indicators on the other hand widens, the fundamental correlation between the two will inevitably force periodic convergences. China’s controlled exchange rate regime is an exception; but, in most other emerging market examples, domestic and global considerations argue in favour of making foreign exchange levels a key threshold of economic and financial health.

The other useful correlation is one which will be created shortly between the Ruble ETF (as it gains popularity and participation) and Russian equity mutual funds. Energy stocks like Gazprom (OGZPF) and Lukoil (LUKOY.PK) are invariably dominant in the weightings of such funds, and the Jonathan Liss post rightly points out the how the Ruble ETF can be employed for pair trading in the oil and gas context.

Speaking about currencies, perhaps the best general standard of how the emerging market economies will respond to the global turmoil through 2009 is India. To this writer’s knowledge no India-specific currency ETF is open for broad public participation. But those interested in following the India story are advised to visit the MCX website to review the possibility of trading Indian Rupee currency forwards. For the record, CDS prices for bellwether Indian banks have breached 500 basis points since early this month, and now appear headed firmly towards 700 basis points in a few short weeks.

This writer is short the Indian Rupee, and intends to add to shorts each time the dollar/INR rate for medium-dated maturities dips below 49.25; 2009 target is 57 rupees to one dollar, a very attractive expectation on leveraged positions.

Comments

[Alex Filonov]

Let's wait till this ETF is liquid enough. Today's volume is 100 shares so far, it's impossible to trade.

2008 Nov 19 01:30 PM

[Vladimir Senkov]

Hi Rakesh,

You mentioned that "this writer" intends to short XRU.
How much of an interest rate are you expecting to pay on that short position? In other words, what do you think is the distribution rate going to be? And if you can give me that number, could you also tell me where that number is coming from?
Thanks in advance,
Vladimir.

2008 Nov 20 12:07 AM