Beware Today's Surge In The Egypt ETF

The Market Vectors Egypt ETF (EGPT) is getting in on Wednesday's ebullience surrounding emerging markets funds as shares of the lone ETF exclusively devoted to the North African nation are higher by 4.2 percent on light volume.

On a pure performance basis, EGPT's 2012 gain of 32 percent looks good, but the ETF stumbled in the latter stages of the year as various domestic and regional issues finally began to catch up with the volatile fund.

Today's surge for EGPT comes with a cautionary tale of its own. The ETF, which allocates 42.5 percent of its weight to financial services stocks, is moving higher despite the fact that Egyptians are running out of their local currency – the pound – and desperately grabbing for U.S. dollars.

The greenback is up more than half a percent against the Egyptian pound today, extending a slide for the Egyptian currency that started in European trading this morning. With Egyptians clamoring for U.S. dollars, the central bank has moved to ration the availability of the U.S. currency, which has prompted elevated buying of euros.

Already home to dwindling foreign currency reserves, a plummeting pound has prompted a surge in credit default swaps used to insure Egyptian sovereign debt against default. Egypt's five-year credit default swaps now stand at around 5.25 percent, meaning it costs $525,000 to insure $10 million worth of Egyptian five-year sovereign debt, according to the Wall Street Journal.

Due to increased political tensions and the aforementioned dwindling currency reserves, which as the Journal notes only cover 90 days worth of exports, Standard & Poor's lowered Egypt's credit rating to B- last week. That is six levels below investment grade. That creates a potential double whammy for Egypt in the form of higher borrowing costs because of the lower credit rating at a time when its pound is losing value.

All this at a time when Egypt is facing slack economic growth and unemployment of around 12 percent. The latter issue could possibly spark more domestic protests because the rate of joblessness for Egypt's young people is more than double the national average.

Investors may have already been bracing for the worst, or at least another decline, with EGPT. The ETF had nearly $55 million in assets under management on September 11, 2012, the same day bloody protests broke out in Cairo. That number has been reduced to $36.3 million as of December 31.

By The ETF Professor