Cyprus Bank 'Tax' And Assets

Includes: FXE, GLD, SPY
by: Chris Ridder, CFA

Over the weekend it was announced that depositors of accounts in Cyprus' banks will be forced to take a "haircut" in order for a bailout to proceed. Initial indications are for a 6.75% haircut for deposits under €100,000 and 9.9% above this amount, although this could change.

This means if an investor had €100,000, then, after the "bank holiday" in Cyprus, they would have €93,250. Of course this news started a run for cash at ATM machines.

The Cyprus banking industry has been known as an off-shore heaven for Russian assets. However, this news will most likely affect all investors and asset classes. Why?

Because the most basic asset of bank deposits, or money, just saw a jump in its "risk premium". Bank deposits, especially small ones, are not supposed to have a default risk premium. They might have a very small "inflation premium", as seen with interest checking for deposits, but generally it was thought that depositors were super-senior and safe from any loss of principal. Now there is talk that this "haircut" will actually be a swap into new bank equity. However, holders of bank deposits, by definition, do not want the risk of owning equity in corporations. Also, would you want to own a business whose management just ran it into the ground?

What does this mean for investors? First, risk has increased so risk-off is the initial reaction. If a build up approach is used to estimate risk premiums, then this news means that all risk assets in Europe have had an increase in their risk premium over the weekend. This makes The U.S. dollar a winner and the euro the loser, as now this "policy tool" is a question mark hanging over every European bank.

Gold is also a winner. International depositors just found out they have more than just "currency risk" with an off-shore bank account.

Cash is a winner vs. bank deposits. Investors now will have to think if it is better to hold cash "under the mattress" or in a safety deposit box. Amazingly, cash just beat a bank account for total return in Cyprus!

So far S&P 500 futures are down, about -1%, after just over 2 hours of trading, so look for SPY to open down.

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Gold is up, about .6%, so look for an up open in GLD.

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The euro has fallen -1.3% from Friday's close vs. the U.S. dollar, and -1.65% vs. the Japanese yen. FXE is the ETF to trade the euro currency.

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In short, Europe's policy makers just opened Pandora's Box concerning the sanctity of bank deposits. My opinion is that this is just the start of a new trend down in the euro vs. U.S. dollar, since investors "on the Continent" can no longer trust their own banks. Also, a lower currency is welcomed by their slowing economies, in order to help exports/hurt imports.

Long Term recommendations:

  • Long: USD vs. EUR
  • Short: FXE

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. I have no positions in any stocks mentioned, but may initiate a long position in GLD over the next 72 hours. I am long gold. I have no positions in any stocks mentioned, but may initiate a short position in FXE over the next 72 hours.