Picking the best ETF to short China

Only hours after raising interest rates the People’s bank of China hiked the reserve requirement for local banks to 15 per cent, signaling a tightening of monetary policy to head-off growing asset price bubbles in stocks and housing.

This is just the start. Zero interest rates around the world have only one way to go and that is up. And that means down is the watchword for stocks and property.

China crisis

The stock market reaction was instantly negative both in China and globally. Is this the end of the global stock market rally seen since the lows of last March? If so how to play the market as it goes down becomes the next question.

It is tough to find exchange traded funds that are particularly focused on China from the short side. Two worth considering are UltraShort FTSE/Xinhua China25 Proshares (FXP) and Emerging Markets Bear3x (EDZ).

Neither ETF is a perfect China short. FXP is a short for the largest FTSE/Hong Kong quoted China stocks. EDZ is a basket of emerging market stocks in which the weighting and down pull of China is considerable. Yesterday EDZ was up 4.5 per cent, FXP up by 4.7 per cent.

A very recent market entrant is the Direxion China Bear 3x ETF for Chinese stocks cross-listed on the US exchanges (CZI). It was up 6.7 per cent yesterday.

The gearing arrangements of these short ETFs mean that you suffer big losses if the market goes up instead of down, and holding them for any length of time in a reversal is very painful and recovery difficult. You would be foolish to put all your eggs in these baskets.

Upside potential

However, the potential upside is also considerable. A year ago FXP touched $50 against just $8 last night. EDZ touched $100 compared with just $4.58 yesterday.

There is the chance to make serious money in these ETFs if the market takes a real downer, or to maximize the uplift from a correction. But these are not for widows and orphans and braver spirits should also take care.

Alternatively you could short US financials with FAZ or SKF or the Nasdaq with QID. If the US markets follow China down, as they certainly would, then these might also be excellent short-term investments, but they do not have the same potential for big gains as EDZ and FXP.