Macro Tsimmis

intelligently hedged investment

Why We are not Shorting the Euro

Posted by intelledgement on Wed, 01 May 13

The slow-motion conflagration raging in the Euro zone is much more likely to speed up than it is to abate anytime soon. With unemployment pushing 30% in Greece and Spain and spiking to all-time highs in France, the potential for social unrest remains at potentially dangerous levels. In fact, the situation is even more volatile than it appears in that the worst unemployment rates are among young workers—who in an environment where new job growth is outstripped by layoffs, find it very hard to secure a first hire. Large numbers of frustrated young males with nothing productive to occupy their time is not a condition conducive to social stability.

So far, The Powers That Be have limited violent unrest much to Greece, and even there, things have quieted down of late. But as the Eurocrats stumble from tactical crisis to crisis in their efforts to keep their TBTF banks alive in the fond hope a miracle will occur, it is inevitable that sparks—such as the recent scheme to confiscate depositor funds from accounts held in Cypriot banks—will fly…and the tinder scattered about is ever more profuse and dry.

Debts that cannot be paid will not be paid. Some banks will eventually collapse, but evidently not before expropriating as many funds from taxpayers, shareholders, bondholders, and customers as possible—with the active connivance of the Eurocrats—in lame attempts to cover their bad debts…or at least extend and pretend.

Whither the Euro?

So, given all this, one might ask, why does Intelledgement not recommend being short the Euro—that is, taking a position that will profit if the value of the Euro currency declines? If the Euro zone is inevitably headed for the dustbin of history, won’t their associated fiat currency end up there, too?

Basically, there are two reasons for our reluctance to go down this road. The first one is the number of variables that influence the value of the Euro. Perhaps the most explicitly political construct of any fiat currency in the history of humanity, the fate of the Euro is much a function of political decisions. For example, what if The Powers That Be decided to disband the Eurozone—or at least suspend the memberships of the weak sisters Italy, Spain, and France et. al.; but for Germany and the relatively stronger northern state economies to maintain the Euro as their currency? Conceivably, the Euro might actually strengthen in such a scenario. In effect, the macro call about the non-viability of the Euro zone could prove out but shorting the Euro would still be a losing proposition.

But if you really, really want to short the Euro…

AAnd then there is the second reason: there is no safe and reliable ETF vehicle available to that can take one down this road. The following table lists all seven ETFs which currently track the Euro—four long and three short:

ETF Symbol Inception NetAss ADV CAGR EURO CAGR PR
CurrencyShares Euro Trust FXE 12-Dec-05  0.3  0.8 1.85% 1.51%  34
iPath EUR/USD Exch Rate ETN ERO 27-Dec-07  0.0  0.0 -3.47% -1.92%  –155
ProShares Short Euro EUFX 16-Jul-12  0.0  0.0 -9.36% 9.37%  1
MarketVectors 2x Long Euro ETN URR 22-May-08  0.0  0.0 -8.46% -3.51%  –145
Ultra Euro ProShares ULE 25-Nov-08  0.0  0.0 -1.15% 0.22%  –160
MarketVectors 2x Short Euro ETN DRR 22-May-08  0.1  0.0 2.03% -3.51%  –499
UltraShort Euro ProShares EUO 25-Nov-08  0.5  1.1 -5.89% 0.22%  –544

ETF = name of the exchange-traded fund
Symbol = ticker of the exchange-traded fund
Inception = first date the exchange-traded fund was traded
NetAss = net assets under management for the exchange-traded fund (in billions)
ADV = average daily volume of the exchange-traded fund (in millions of shares)
CAGR = compounded annual growth rate of the ETF from inception to 30 Apr 13
EURO CAGR = compounded annual growth rate of the EURO from inception of the ETF to 30 Apr 13
PR = Performance Rating, viz., the difference between the CAGRs of the EURO and each ETF since its inception (the higher the PR, the better for the ETF)

Note: the leveraged ETFs are rendered in darker green (for 2x long) or darker red (for 2x short); non-leveraged ETFs are in lighter green (for long) and lighter red (for short).

As a general rule, we do not recommend investing in ETFs with less than $1B of assets and fewer than one million shares traded on average each day. This is because thinly traded/owned equities—and ETFs are no exception—are particularly vulnerable to market volatility. For example, if some overnight news development changed the situation sufficiently to warrant liquidating your position, a thinly-traded ETF is likely to be harder to sell at a fair price on a down day than one that is widely traded, and you could suffer a materially exaggerated loss just in that one day.

There is no pick of this litter

Well, of the seven ETFs that track the Euro, not a single one of them meet our criteria. The double inverse ProShares Ultrashort ETF (EUO) is by far the most popular, with $520 million under management and an average daily volume in excess of one million shares traded. It is also the worst performer of the seven, having lost 6%-per-year in value since 2008 when one should have expected—with the value of the Euro up an annualized 0.22%—a loss of less than half-a-percent. This is typical of “ultra” ETFs; the other 2x short fund— Market Vectors Double Short Euro ETN (DRR) —is underperforming expectations by 5% per year (which is terrible) and both ultra long funds are underperforming by 1.5% per year (which is very bad). It is almost never a good idea to own any leveraged ETF; their design parameters virtually guarantee they will underperform expectations.

In theory, you could short the long funds instead of buying a short fund. The granddaddy CurrencyShares Euro Trust Fund (FXE) would not be a good choice for that strategy: it is one-third a percent ahead of where you would expect it to be on an annualized basis after eight years in operation. (A worthy option should you want to go long the Euro, though.) The other long fund— iPath EUR/USD Exchange Rate ETN (ERO) —as well as both 2x long funds are all underperforming by 1.5%/year, which sounds good if you’re betting against the Euro…but all three of them are very thinly traded, which practically speaking means it would be hard to find margined shares to sell short…and, of course, if you did establish a short position, your risk of losing big should the market move against you before you can unwind is materially greater with a thinly-traded equity.

The new unleveraged ProShares Short Euro fund (EUFX) —not even in operation a year, yet—is off to an excellent start, tracking the Euro perfectly: the Euro is up an annualized 9% since the funds inception, and the fund shares are down 9%. If your impulse to short the Euro is irresistible but you are not ready to speculate in the FX markets directly, this ETF bears watching, although so far the fund has attracted only $4 million in net assets and volume is a bad joke.

All things considered, you’ll probably be better served just buying more pre-1965 circulated dimes and quarters, or another tranche of PHYS, than shorting the Euro.

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