logo

If you’re investing in emerging markets, you need to do this to hedge: Trader

VIDEO3:5703:57
Can the emerging rally continue?

Emerging markets may be outperforming U.S. markets this year, but Brian Kelly of Brian Kelly Capital isn't buying into these markets at their current levels.

The ETF tracking the MSCI emerging markets index, EEM, is up nearly 14 percent over the past three months, while the has risen about 6 percent.

Kelly says this outperformance is due in part due to the dollar cooling off a bit recently. While he says he "wouldn't be a buyer of EEM at these levels" due to its chart pattern as well as its apparent reliance on the U.S. currency, he says there is a hedging trade that may make sense.

Those who want to stay long the EEM, he says, ought to also buy the UUP, the ETF tracking the dollar index.

"It's almost a hedge to the EEM. If you get a strong dollar, EEM is likely to come down. I don't know if it makes a new low," Kelly said Wednesday on CNBC's "Trading Nation. " "UUP, the up-dollar ETF, will actually do pretty well so that will be a way to hedge that position."

Indeed, the correlation between the EEM and the UUP over the past three months has been -0.6, indicating a strong opposing relationship between the two ETFs.

This relationship is likely due to the commodity markets. As the dollar weakens, commodities tend to do better, and many emerging markets are highly commodity sensitive.

The EEM's exposure is heavily focused on Asian markets, with about 25 percent of its holdings tracking China, 15 percent South Korea, 12 percent Taiwan and 8 percent India.