Kyle Bass: Bearish On The European Banking System

by: Parsimony Investment Research

Hayman Capital’s Kyle Bass has recently published two must-read investor letters updating investors on Hayman’s view of the ongoing sovereign debt crisis. We follow Bass closely due to his ability to breakdown very complicated issues such as the global debt woes of the developed world with simple arguments with a degree of pragmatism.

This week Bass published a brief note to investors outlining his concerns over a potential bank run on deposits in the periphery countries of Europe. According to Hayman, capital mobility is an essential precondition to default as capital flees problem jurisdiction. U.S. investors need to be aware and concerned about the European debt situation due to unforeseen consequences on the global banking system.

The graph below outlines a historical perspective on capital mobility – a precondition to default and banking crisis.

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Source: Carmen M. Reinhart and Kenneth S. Rogoff: Banking Crises: An Equal Opportunity Menace

Bass goes onto points out that M1 deposits in the periphery are already under stress, with Greece, Portugal and Ireland experiencing increasing rates of declining deposits.
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Bass has been increasingly vocal on the problem that the developed world sovereigns face. Hayman believes the pending 2012 eurozone break-up will only accelerate problems face in Japan and ultimately the U.S.

We continue to believe that the investing public underestimates the risks to a full blown banking crisis. imilar to what the U.S. and ultimately the world experienced after the Lehman collapse, we believe investors should be very cautious as to the unknown unintended consequences. Holding zero percentage yielding cash provides the ability to buy up cheap assets in a crisis. Similar to indiscriminate selling of assets in the 2009 meltdown we think investors and traders should increase their allocation to cash and crisis seeking securities.

Tactical Strategy

Investors looking to profit from turmoil in the eurozone could either short the Currency Shares Euro Trust (NYSEARCA:FXE) or go long ProShares UltraShort Euro (NYSEARCA:EUO) or Market Vectors Double Short Euro (NYSEARCA:DRR). Bass has been very bearish and very vocal about the debt problems in Japan. The PowerShares DB Inverse Japanese (NYSEARCA:JGBS) and Powershares DB 3x Inverse Japanese Gov Bond (NYSEARCA:JGBD) ETNs provide investors an opportunity to profit from a decline in Japanese Government Bonds.

We also own gold and silver in physical and ETF forms (GLD and SLV) due to what we see as only one real solution to the developed world debt crisis. We believe central banks over the world will continue to print money and buy bonds when the private sector shuns government debt.

Disclosure: I am long JGBS, GLD, SLV. Long physical gold and silver. Short euro futures.