Egypt ETF (EGPT): An Opportunity Best Avoided

The developments from Egypt which have dominated the news are drawing to a conclusion with the announcement of Hosni Mubarak that he will not be seeking re-election later this year. As you would expect, all the attention focused on Egypt has also brought attention to its financial markets. The Egyptian stock exchange is extremely small compared to the major markets and because of the social turmoil it has been shut down since this all began.

The only door to the Egyptian equity market that is left open is the Egypt ETF (EGPT) which is still – miraculously – trading on the US market. Egypt’s equity market fell by 6.5% after the unrest began and before it was closed. As measured by this ETF, the market fell by 26% within 18 days. Many will look at this as the proverbial ‘buy when there is blood on the street’. Or they may like to participate in the overthrow of a dictatorship and the birth of a democracy – however tangentially – through the stock market. But this is one opportunity best avoided.

Consider that this ETF is less than a year old and it is tiny with a thin float. As well, the volume has exploded as retail investors have rushed to buy EGPT; a few thousand shares in early December compared to more than a million this week. Because a few of the the underlying securities are individually traded on western markets the fund’s custodian (Bank of New York Mellon), is making a semi-educated guess. Even so, the rush of new investors has pushed the fund into a premium level it has never seen in its young life:

Before the Egyptian protests, EGPT tended to trade within a narrow premium to discount band. Yesterday it spiked up to 14% premium and today it closed at 12.5% premium to NAV 9right hand scale in above chart). As well, the fund’s sponsor, Van Eck stopped creating new shares so the mad dash to buy the ETF has swelled the fund’s cash position. Before it was 0.09% of the fund’s asset and now it stands at slightly over 40%. All of this translates into a very high risk situation.

I remember during the 1997 Asian fianncial crisis, many country closed-end funds were trading at astonishingly high premiums after their NAVs had plummeting. Whoever bought those shares still lost money. That’s because while the Asian equity markets did eventually return to normalcy, those premiums shrank as well, working against the position. The Egypt ETF is not a closed-end fund but because there are no new shares being created for the moment, it is trading like one.

It is difficult to estimate just where the Egyptian stock market will open – after all, that is what a free market’s price discovery mechanism is for. I don’t envy whoever is given the task of placing a number on this ETF’s NAV daily. For a hint we can look at the Tunisian stock market. After all, this is ground zero for what is happening in the Middle East right now. The Tunisian Stock Exchange opened after this week after several weeks of being closed. It dropped -2.6% on Monday and again, -2.5% today.

Finally, having the history of the Iranian revolution still fresh in my mind, I can’t help but see the parallels. Then, just as now, the Iranian economy had improved over the past decades providing the impetus for people to want more. The political situation was stiffing with the Shah’s regime brutally cracking down on dissidents along the complete political spectrum.

Many don’t know, but the Iranian revolution had little to do with religion at the onset. Only after a protracted and chaotic process following the removal of the Shah’s regime did the Islamic extremists wrest control from the other factions and forg the despotic regime that is still in power today. Very few revolutions have resulted in a future government that was an improvement on the last. Here’s hoping that Egypt makes one more exception to that rule.

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