The Egyptian ETF: A Cautionary Tale

After a delay this morning, the Egyptian ETF—the Market Vectors Egypt Index opened up 5 percent. While this is a good sign, traders should approach the interpretation of this trading with great caution.

Here's the problem: the EGPT is supposed to correlate with the Egyptian stock market, but that has been closed for days. How do you price an ETF when the underlying index is closed?

You guess. And here's the good news: traders can provide price discovery even when underlying markets are closed.

Here's the bad news: Van Eck, which runs the fund, has announced they are suspending the creation of new orders. This is normal when the underlying market is closed for an extended period.

  • (Watch CNBC's Herb Greenberg: Why Investors Should Skip the Middle East)

Why? They create shares by taking the cash from investors and buying shares on the exchange in Egypt. But the exchange is closed, so there is no way to create new shares.

What does this mean? It means that this fund is operating as a type of closed end fund. If there is sudden demand from investors (this is a tiny ETF: $11 million in assets on Friday) the price will go up because there is a limited supply of shares available, not necessarily because the fundamentals are improving.

The good news is that other exchanges in the Middle East—in Qatar, UAE, Kuwait, are all trading up fractionally to up 1 percent (Saudi Arabia is down), so directionally this up move in the EGPT may be correct.

Still, the truth is, we have no idea where the Egyptian market will be trading in the next few days, nor do we know when Egypt will reopen.

If the ETF is indeed trading at a premium, when van Eck reopens the creation window, we would expect the premium window to collapse. This has happened before, when India cracked down on foreign capital.

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