Currency ETFs: Pause For Concern On Chinese Renminbi ETN

Year-over year, the CurrencyShares Euro Trust (FXE) is up 19%. I once referred to the Euro as the closest thing to a "sure thing."

Since the Euro's early struggles in 2000, it has gained 85% against the U.S. dollar. The Euro actually lost significant ground in 2005, when the Fed was raising rates. Yet for the most part, the U.S. dollar struggled in the weak economic years of 2000-2003... and it has found new trouble in 2007-2008 as we fight off another recession.

Yet if typical economic cycle forces prevail, the U.S. dollar may begin a recovery against the Euro in 2008-09. The "bet-against-the-dollar" folks will be at a loss to explain why they didn't see a change in the works.

That said, the next "sure thing" currency is the Chinese dollar, also known as the "renminbi." The reason the Chinese dollar will prevail is that it had been artificially pegged to the U.S dollar for far too long. And even today, the Chinese government does not allow its currency to trade freely.

Nevertheless, over time, there is simply no currency that will rise as quickly against the U.S. dollar, or the Euro, quite like the renminbi. And for exchange-traded enthusiasts, you finally have your first vehicle: Market Vectors - Chinese Renminbi/USD ETN (CNY).

Matt Hougan of Index Universe explains that the exchange-traded note CNY will go up in value when the renminbi appreciates against the U.S. dollar. It will go down when the U.S. dollar strengthens against the Chinese currency. (The long-term likelihood of the latter is small indeed!)

So why wouldn't I be jumping through hoops to recommend the new Market Vectors - Chinese Renminbi/USD ETN (CNY)? Simply put, exchange traded notes, or ETNs, are different than exchange-traded funds. They carry risk other than currency risk... specifically, credit risk.

The debt vehicle CNY is subject to the credit of its underlying brokerage, Morgan Stanley. And while Morgan Stanley may not be a "Bear Stearns in waiting," who is eager to purchase the debt of investment brokerage houses? At best, this is a cause and a pause for concern.

If the underlying institution were Barclay's, one of the world's largest banks by market capitalization, I'd feel a whole heck of a lot better. Unfortunately, it's Morgan Stanley. So for the time being, as much as I love the idea of accessing the appreciation potential for the Chinese renminbi, I am going to hold back.

After all, Barclay's is introducing currency notes of their own. Coming soon? The Asian and Gulf Revaluation Fund. It will be tracking an index of Middle Eastern and Asian currencies tied to the U.S. dollar, from the renminbi to the Saudi Arabian "riyal" to the Singapore dollar to the UAE's "dirham."

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.

Comments

[Brad Johnson]

Gary,
Thanks for that important clarification. I just stumbled across this ETN last p.m. and after evaluating it (not much data of'course as it is so new) it was sounding too good to be w/o some risk other than the typical difficulty in judging short term relative currency changes. I have been using ETF's since the late 90's and have a position in another Van Eck ETF (RSX), but have yet to purchase shares in an ETN. Your clarification of the credit risk hit me upside the head like a hammer as I think I was seeing no downside in a long term bet on the renminbi. Thank you. Have any ideas on Morgan Stanley's exposure to the subprime debacle?
Thanks, Brad