Short Nigeria! Don't Get Shot On The Frontier

Includes: NGE, UUP
by: Sam Kovacs


The Nigerian government is keeping their currency at an irrationally high level.

Sooner or later, Nigeria will loose their struggle in the global currency wars.

A Naira devaluation would also hurt the NSE.

The wave of American westward expansion during the second half of the nineteenth century has left us with a rich heritage of bedtime stories, and movies. The American frontier, or the Wild Wild West wasn't a place for the faint of heart.

Nowadays when we use the term "frontier", we refer to capital markets from the developing world which are investable but less established than emerging markets. Countries such as Nigeria, Pakistan and Bulgaria come to mind.

Over the course of the last few years, investors have been lured to these markets in the hope of better returns than they can achieve domestically. However there are many caveats, and a lack of analysis of the political and economic landscape could be enough for your investment to be shot down in plain sight.

Granted, west of the Mississippi river a couple of centuries ago, it would have been you and not your investment, lying outside the saloon bleeding out.

Source: Caleb Kuhl

I have spent the first 3 months of 2016 discovering and confronting aspects and approaches of the financial markets which I had overlooked up until now.

I have jumped with both feet into the realm of global macro investing. The idea is to analyze the general flow of funds, political changes, government policies, inter-government relations, and other broad systemic factors to amount to an opinion concerning the direction of indices, currencies, and commodities.

To put it short, when George Soros shorted the Pound in 1992, we could have classified the trade as Global Macro. Geopolitics would be a good synonym for Global Macro.

My curiosity implied a new reading list. Here are the books which I recommend:

Such a top down approach, if well done can be extremely profitable. For example, having a bullish bias towards Russia in 2015 would have been quite profitable.


Nigeria became Africa's biggest economy literally overnight in April 2014, when it rebased the GDP for the first time in over two decades. All of a sudden Nigerian GDP was 89% higher. This was just three months before the end of the bull market which double the value of the Nigerian stock exchange in just three years.

Source: Bloomberg

The rest is history. During the second half of 2014 Oil collapsed, and so did the Nigerian Stock Exchange. Commodities worldwide collapsed in price, and the Dollar soared against other currencies. Throughout 2015, the situation went from bad to worse for Nigeria. Oil represents the vast majority of the country's exports. It wasn't much of a surprise to learn that exports declined 20% in 2015 which reduced foreign reserves by 32.5%. While real GDP growth slowed from 6% to just above 2%, the upsurge in inflation and unemployment topped off the economic disaster.

The currency, which is pegged to the USD was devalued twice: Once between October and November 2014, and again in January 2015. These two devaluations only compensated for the USD's rise over that set time frame, effectively leaving the Naira's situation unchanged in regard to the rest of the world. This comes extremely apparent when charting the Naira/USD rate and the Dollar Index (NYSEARCA:UUP).


It seems peculiar that the Buhari government has taken a firm stance against devaluing the money, especially since nobody is buying it (pun intended). His economic advisors agree with him and encouraged him to sign off huge government spending as a way to "fix" the economy instead of devaluing the Naira.

I disagree, sooner or later government will have no choice but to devalue. When forex rates are maintained at unrealistic levels, we can turn to black market data to have an estimate of how supply and demand price the currency. While some say that these rates are good proxies for a free market rate, I believe they might slightly undervalue the concerned currency, since an element of scarcity could be priced into the exchange rate.

However, it comes extremely apparent that the economic conditions in Nigeria call for further devaluation of the official rates. Your Naira are worth 40% less on the black market today than they were at the time of the last devaluation.


According to Investopedia parallel currency markets appear in economies where:

  • Weak economic fundamentals, such as a high rate of inflation and limited foreign exchange reserves.
  • Strict currency controls that limit the amount of foreign currency available to residents.
  • A fixed exchange rate regime where the domestic currency is pegged at an unrealistically high exchange rate to the U.S. dollar or another global currency.
  • A lack of confidence among the citizenry in the value of the domestic currency.

All four of these conditions prevail in Nigeria. President Buhari believes massive government spending in infrastructure will inject the needed cash to boost the economy. Just recently he accepted a N6 trillion budget. Given the current assumptions this would be enough to double the country's debt.

Source: Pwc

Questions have been raised concerning available financing. Rumors of the IMF arranging a loan which would cover around 10% of the expenditure. It is unclear where the rest of the needed money would come from, and at what rate the country will be able to borrow. Just three months ago Lagarde mentioned during a trip to Nigeria that no loans were needed, and that the IMF wouldn't intervene in Nigeria. Change of hearts Christine?

More alarming still, is the growth in Money supply. Year over Year it is up over 8%, outpacing by far the growth of the economy. Since the official rate hasn't changed, inflation has crept back up throughout Nigeria from 8.5% in early 2015 to 11.5% right now. Something's got to give.

So this is my question to Mr. Buhari and his government:

Is your pride blinding you from the obvious fact that you currently have but two choices? You can maintain the current peg, in which case inflation will spur at any unpredictable moment, in places of the economy you least expected and spread irrationally at an uncontrollable rate. Or you could face the facts, and devalue your currency to it's true worth. The black market rate calls for 320 Naira/USD. Why not meet them half way at 260, and adjust accordingly in subsequent months?

Ultimately, I believe the choice is closer to: devalue now or later?
The increasing unemployment and climbing inflation will eventually lead to such unrest in the economy, that the government will have to reconsider.


There are two ways that investors can short the Naira:

  • First you could short a ZAR/USD future as well as go long a ZAR/NGN future to obtain the desired exposure. Probably quite a costly approach.
  • Or, and this is my favored approach, you can short this Nigerian ETF (NYSEARCA:NGE) provided by Global X. The ETF reproduces the MSCI All Nigeria select 25/50 index, and index including the most liquid Nigerian stocks.

Since all of the ETF's holdings are in Naira, yet the fund is quoted in USD, a Naira devaluation would have a direct impact on the value of the fund. When I first considered using this instrument as a way to short the Naira, one element kept bugging me: What if the Nigerian Stock Exchange goes up?

I decided to research more about the exchange, and to test a few hypothesis. This is what I came up with:

  1. Both periods of devaluation led to losses on the NSE.
  2. In any given month 35%-65% of all transactions on the Nigerian stock exchange come from foreign portfolio investments (FPI).
  3. These investors if not hedged are exposed to currency risk, and in anticipation and during the aftermath of a devaluation are likely to liquidate their Naira holdings creating a strong selling pressure on the stock market.
  4. Net FPI flows had an 0.4 correlation with the returns of the Nigerian stock exchange. While 60% of the variance remains unexplained, this would testify that for the observed sample (the last 38 months), there has been a clear relationship between both.
  5. Despite major portfolio outflows in 2014 and 2015, the net inflows since 2009 into Nigeria still amount to Ngn 250 bn. At the current exchange rate this equates to another $1.25 bn which has entered the country during the last 7 years and hasn't yet exited. This opens the door to the possibility of future outflows.
  6. During the observed sample only in 4 of the 38 months were FPI outflows at least twice as important as FPI inflows. Each time that happened, the NSE was down. Coincidence, or interesting data point?

How do we make sense of this data? A currency devaluation will inevitably lead to foreign portfolio outflows. If these are important enough, they will likely amount to a powerful selling pressure on the Nigerian stock exchange, muting any potential recovery of the index while waiting for the short to play out.

Source: Nigerian Stock Exchange,

Source: Nigerian Stock Exchange.


For every George Soros, there is a handful of unfortunate macro plays, and the strength of the dollar is one key element which could mute this strategy's returns. If the dollar wanes severely in the next few months, the Nigerian government might not feel the urge to change the peg, thus hindering returns. It is also important to track Oil, since any sustained rally could suffice to spark the Nigerian economy on the right track.

I would reevaluate my stance on NGE in either case, and will also do so by the end of 2016. Tracking the level of the black market rates would also be wise.

Disclosure: I am/we are short NGE.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.