The Impending Collapse of the 30% Premium for EGPT

February 11, 2011 by  
Filed under Commentary, ETFs

Note:  The Egyptian Exchange extended the closure multiple time.  Therefore, the timeline for the collapse scenario outlined below has been delayed.  The premium for EGPT will disappear once share creation resumes, which is estimated to be one or two market days after the Egyptian Exchange reopens.

Many current investors and traders of Market Vectors Egypt (EGPT) believe that it is an ETF and a true proxy for the Egyptian stock market.  Others are aware that new share creation for EGPT was suspended on January 31, making it a de-facto closed-end fund trading at a premium.  Few are cognizant that a snafu at Van Eck caused EGPT’s cash position to swell from 0% to 50% before share creation could be halted.  My article EGPT Now 50% Cash With A Hefty Premium For That Cash warned investors of these events and the potential implications.

Meanwhile, time has passed, Mubarak has stepped aside, and the Egyptian Exchange is scheduled to reopen on Sunday.  The key question is what happens next.  The prevailing sentiment is that once reopened, Egypt’s stock market will rally to match the value of the EGPT fund (I hesitate to call it an ETF at this juncture).  I believe prevailing sentiment is wrong.

EGPT closed at $18.597 in Friday’s (2/11/11) trading.  The Indicative Value for EGPT closed at $15.642, placing EGPT at what appears to be an +18.9% premium.  That premium applies to everything in the portfolio, including the current 38.2% cash position.  No investor in their right mind would assign a premium to cash, therefore the premium must apply only to the 61.8% of the portfolio that is invested.  The resulting premium on the equity allocation is therefore more than 30%.

For EGPT to be a true proxy of the underlying value implies that Egypt’s stock market will surge 30% on the day it reopens.  Possible, but not probable.  The nation’s primary benchmark, the EGX 30, last traded at 5,646.50 and a 30% increase would put it at 7340, a level not seen in more than nine months. 

Here is a more likely scenario of what will happen:

  • The Egyptian market reopens for trading on Sunday as scheduled.  The EGPT fund deploys its 38.1% cash on Sunday and Monday in an attempt to become fully invested again.
  • Astute traders will monitor the two days of trading in Cairo that will take place before U.S. markets open on Monday in an attempt to estimate the Indicative Value of EGPT and work their plans to arbitrage the premium when U.S. trading opens.
  • Trading on Monday should partially reduce the premium for EGPT but not eliminate it since it will still be trading as a closed-end fund.  However, uninformed traders could potentially push the premium even higher thinking EGPT could rally further.
  • A number of hours after the close of trading on Monday 2/14/11 in the U.S., Van Eck will post the new “fully invested” indicative value for EGPT on the Market Vectors website along with the closing price and premium calculation.
  • Van Eck will review its ability to deploy cash and establish plans and procedures for the resumption of share creation.  Unlike most ETFs, EGPT accepts cash at the Indicative Value for share creation instead of requiring an “in-kind” exchange.
  • No sooner than before U.S. markets open on Tuesday (it may take longer), Van Eck will announce the resumption of new share creation.  Once new share creation commences at the Indicative Value, the EGPT price premium will collapse with the share price dropping to the new Indicative Value.

One criticism of my analysis is that the Indicative Value is based on prices prior to the close of the Egyptian stock market.  It is therefore stale and inaccurate, and my premium calculation is incorrect.  My counter argument is that the EGPT Indicative Value has been continuously updated during U.S. market hours through this whole process. 

Some of the larger holdings are traded in London and Canada, and Van Eck was able to whittle the cash allocation from over 50% to near 38% through purchases in those markets.  By prospectus, EGPT is to calculate the Indicative Value (Net Asset Value) “based on fair value prices” which implies using the London and Canada prices for securities traded there and third-party estimates for others. 

Additional resources:

Disclosure covering writer, editor, and publisher:  No positions in any of the securities mentioned.  No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

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