The anti-government protests in the streets of Egypt have dominated the headlines for the last week, as hundreds of thousands of Egyptians have continued to push for the resignation of their long-standing president. While the protests have been generally peaceful to this point, the demonstrations have cast an uncertain future over the north African country. Though the Egyptian economy is relatively small, the country’s control of strategically important assets such as the Suez Canal and outsized demand for key commodities have rippled throughout global financial markets. Oil prices have surged in recent sessions, while uncertainty lingering over neighboring Middle East economies has battered stocks.
The Egyptian stock markets have of course also been taken on a wild ride; the country’s main index slumped more than 15% in the two days following the start of the protests, before the government shut down the stock markets amidst escalating protests and increasing anxiety. The Egyptian Stock Exchange has now been closed for nearly a week, though it is expected to reopen for trading on Monday assuming no major setbacks. “The return of activity on the exchange on Monday is also conditional on the stability of activity at banks when they return,” exchange head Khaled Serry Seyam told the official MENA news agency on Wednesday.
There is a saying that crisis begets opportunity, and the ongoing crisis in Egypt has attracted hordes of opportunistic investors looking to profit from big swings in the price of Egyptian stocks. Although the Egyptian markets have been closed, trading in the Market Vectors Egypt ETF (EGPT) has been extremely active in recent sessions. Prior to the start of the protests, EGPT had about $12 million and assets and traded an average of just 7,500 shares daily. But over the last week the price of EGPT has swung wildly back and forth, and volumes have surged. On Tuesday, more than 1 million shares traded hands–almost 150 times the average volume:
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The surge in interest in the Egypt ETF, coupled with the extended closing of the Egyptian stock exchange, has created some challenges for the ETF issuer behind the fund. Van Eck announced earlier this week that it had suspended creations of the ETF, with the expectation of resuming this process once the market in Cairo reopens. That doesn’t mean that trading in the fund was halted, but rather that Authorized Participants no longer have the ability to create new shares to meet the swell in investors demand. As a result, EGPT is trading like a closed end fund.
Though the trading volumes indicate that EGPT is a very liquid security, the fund has recently been trading at a huge premium to its net asset value. The premium has spiked because of the inability to price the fund’s underlying assets; with trading in Egypt suspended, the prices used to calculate the NAV are now more than a week old - and obviously don’t reflect some significant developments that have taken place since the exchange closed. Those traders buying and selling EGPT are essentially betting on where the market will open when trading finally resumes. Judging by the fact that EGPT is trading at a premium and not a discount, many investors believe that the situation has improved considerably over the last week.
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This isn’t the first time that ETFs have been used as price discovery vehicles when trading in the underlying securities has been halted. In October, a surprising USDA report sent corn futures surging, and trading was quickly halted after prices jumped by the maximum allowable amount. With futures markets frozen, investors turned to the futures-based corn ETF (CORN) as a price discovery vehicle; not surprisingly, investors accurately predicted the opening for the underlying contracts.
Creations Suspended, Cash Accumulates
The bizarre situation has yet another twist that further complicates the pricing of the Egypt ETF. Most ETFs utilize in-kind creations, meaning that APs must gather the underlying stocks in order to create new shares. But EGPT is unique in that it offers cash creations, meaning that APs can deliver cash to Van Eck in exchange for new shares; the issuer then will generally turn around and invest the cash into Egyptian stocks that make up the underlying index. Last Friday, EGPT took in about $12 million in cash - essentially doubling the asset base - but was unable to deploy the capital before the markets closed. As a result, almost 40% of EGPT’s portfolio - about $10 million - is currently tied up in cash. That means the fund’s premium - currently about 12.5% - could be considerably higher if the fund were fully invested in Egyptian equities.
The folks at IndexUniverse note that Van Eck has the option to invest in ADRs of certain Egyptian stocks traded elsewhere; Orascom Construction, Orascom Telecom, and Centamin Egypt Ltd. trade in London, while Transglobe Energy trades in Canada. So it’s possible that the fund will shift cash into positions in these stocks in coming days, thereby reducing the cash position.
Caution should be used when considering an investment in the Egypt ETF in the current environment, as there are a number of additional risk factors to consider given the prolonged halt in trading of many of the underlying securities. Buyer beware!
Disclosure: No positions at time of writing.
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