Physical Network Coding (PNC) has recently been proposed for multi-antenna Two-Way Relay Networks (TWRNs) with independent fading channels because the total network throughput could be significantly improved. However, PNC for multi-antenna TWRNs with correlated fading channels has not been considered yet. This paper thus considers an important class of multi-antenna TWRNs with the following properties: single-antenna source nodes and two-antenna relay; distance between source nodes and the relay is significantly larger than that between antennas of the relay; and channels between source nodes and the relay are correlated. For such a system, we first propose a novel correlation model that facilitates an easy method to create fading channels with certain correlation properties. We then propose an ovelreceiver design for correlated fading TWRNs. Simulation results show that the proposed receiver design provides much better error performance than the well-known Log-Likelihood Ratio (LLR) algorithm proposed in the literature.