By Nick Giambruno, Senior Editor, International Man, Casey Research
Recently, legendary crisis investor Doug Casey and I put our boots to the ground in Cyprus to search the rubble of one of recent history’s most significant financial crises—the financial collapse and bank deposit raid in Cyprus—for incredible bargains. And we found them.
The fact of the matter is that there are sound, productive, and well-run businesses that are listed on the Cyprus Stock Exchange that continue to produce earnings and pay dividends.
The crisis has created a remarkable opportunity to pick up these companies and other tangible assets at bargain prices that could show very large returns.
Some of these companies are now trading far below their cash values, most are trading below 50% of their book value, and some are even trading under 10% of book value… literally pennies on the dollar.
The crisis in the Cypriot financial system is not going to completely destroy these solid companies, many of which have been around for decades and have survived far worse times. And it certainly won’t undo the geopolitical value that so many civilizations throughout history have placed on the island itself.
Cyprus has been a strategic piece of geography for thousands of years, due to its location at the crossroads between Europe, Africa, the Middle East, and Asia. For this reason and others, Cyprus has been coveted by many ancient and modern civilizations. The Egyptians, the Greeks, the Phoenicians, the Assyrians, the Persians, the Romans, the Byzantines, the Venetians, the Ottomans, and the British all understood that this island in the eastern Mediterranean has great intrinsic value. It is unlikely that a collapse of the paper Ponzi-scheme banking system in Cyprus is going to alter what these civilizations found valuable for thousands years. But it has made anything connected to Cyprus temporarily very cheap.
The Financial Crisis in Cyprus
By now we’ve all heard about what happened in Cyprus in the spring of 2013. The two largest Cypriot banks (Laiki Bank and Bank of Cyprus) gorged on Greek government bonds, hoping to profit from their higher yields. Management thought they were going to make a killing by locking in returns of 5% or 6%—more than double what most Eurozone government bonds were paying. When those bonds were crushed (yields spiked past 40%) by Greece’s sovereign debt crisis, the capital of the two banks, along with most of their depositors’ money, was wiped out. The Cypriot government couldn’t afford to bail out the two banks, and the EU wouldn’t bail them out because so much of the deposits were owed to non-EU Russians. What eventually took shape was a bankruptcy proceeding on horseback that became known as a “bail-in.” It was the depositors that got lassoed.
As usually is the case when financial facts catch up with psychological denial, it all happened on a weekend, on an otherwise ordinary Saturday morning, when bank managers were safely out of the office. On March 16th 2013, without warning (at least to those not part of the political elite), all Cypriot banks were shut, and all accounts were limited to small ATM withdrawals. Capital controls were imposed to prevent money from leaving the country. Cash-sniffing dogs (the less joyful but financially more serious cousins of drug-sniffing dogs) appeared for duty at seaports and airports.
Initially it was announced that all bank accounts would be subject to “an upfront one-off stability levy.” That would have been a theft, pure and simple, of customer deposits in sounder institutions (i.e., banks other than Laiki Bank or Bank of Cyprus) and a default on the implicit promise that accounts under €100,000 in every bank in the EU would be safe. The Cypriot government later backed down and announced that only accounts above €100,000 and only at the two troubled institutions would be bitten. In the end, every large account holder at the Bank of Cyprus lost 47.5% of his balance above €100,000, and those at Laiki Bank lost 100% of everything over €100,000.
The event destroyed confidence in Cyprus, and a crisis ensued.
The Real Story on the Ground
Given what has been said in the media about the bank deposit confiscations and capital controls, you might expect there would be street riots in Cyprus, as there have been in Greece. That’s just not the case, though. Perhaps the riots are still to come. The full bite of austerity hasn’t yet been felt, and unemployment is likely to increase. But for the time being, no riots.
While it is true some Cypriot individuals and business suffered in the banking fiasco, most Cypriots did not—which is why they aren’t rioting. The locals escaped direct harm because they generally kept their money in small, co-op banks that were not subject to the deposit haircut. Most depositors who got hurt at the two haircut banks, Laiki Bank and the Bank of Cyprus, were big-money foreigners, specifically Russians. Remarkably, despite being trimmed of billions of euros, the Russians have not abandoned Cyprus.
Gateway to the EU
As a (relatively) stable country in a tough neighborhood, Cyprus serves as an escape hatch for people from the neighboring countries of the Middle East and as a gateway to the EU, particularly for Russians. Before the crisis, Cyprus was Russia’s undisputed top offshore jurisdiction. It’s only a three hour flight from Moscow, and it offers convenient access to the EU markets and euro-based financial system.
Cyprus has no significant exports, at least for now.
In 2011, Houston-based Noble Energy discovered Aphrodite, a massive gas field about 100 miles south of Cyprus. Aphrodite is estimated to contain 5 to 8 trillion cubic feet of natural gas, worth tens of billions of dollars—enough to turn the cash-strapped island into an energy exporter.
But for now the economy is dominated by services (81% of GDP), namely tourism and financial services. Tourism lives off the island’s warm winters and beautiful beaches. The financial services industry business is a product of the historical factors mentioned below.
First, there are tax and regulatory advantages. The corporate tax rate used to be only 10%, the lowest in the Eurozone. After the crisis, the European Commission, the European Central Bank, and the International Monetary Fund (together known as the Troika) mandated that the corporate tax rate be increased to 12.5%, which is still the lowest in the Eurozone and matched only by Ireland.
Second, Cyprus has double-taxation treaties with 50 countries, which helped make it a popular place to domicile a company. These treaties are extremely attractive to sophisticated financial players in today’s highly taxed world.
Third, Cyprus has strong legal and accounting professions. This is a legacy of British colonial days, much as with the strong legal and financial institutions the British left behind in Hong Kong and Singapore. Cyprus is the only country in Europe besides the UK (and its possessions) and Ireland to have the British legal system (common law). Court cases decided in Britain have weight as precedent in Cypriot law.
This has helped Cyprus develop strong institutions and a rule of law. Many have credited the strong institutions for the speedy economic recovery from the 1974 invasion by Turkey. That being acknowledged, almost everyone we spoke with pointed out that the country is part of southern Europe, where rules can always be bent.
Fourth, unlike most countries of southern Europe and the eastern Mediterranean, almost everyone speaks English. This is a huge advantage, in that English is the world’s lingua franca and definitely the language of trade and finance.
Conclusion
Baron Rothschild may have been an unsavory character in many ways, but he was absolutely correct when he stated that “the time to buy is when blood is in the streets.” This statement perfectly captures the essence of crisis investing.
The Chinese symbol for crisis is actually a combination of two symbols: the symbol for danger and the symbol for opportunity. The danger is what everybody sees; the opportunity is never quite as obvious as the danger, but it’s always there.
Massive fortunes have been made throughout history with crisis investing, by which astute investors took advantage of the semi-hidden opportunities wrapped in an outward cloak of apparent danger in crisis markets.
It is how the Russian oligarchs became oligarchs in the first place. In the wake of the collapse of the Soviet Union, they were able to see through the evident danger to the enormous hidden opportunity that was present at the time. They had intestinal fortitude and bought when the blood was in the streets. They picked up some of the crown jewels of the Russian economy for literally pennies on the dollar and then went on to make fortunes.
Similar opportunities, albeit on different scales, are possible in other countries around the world today.
Case in point: Cyprus.
One important catalyst I recommend you keep an eye on is the relisting of the restructured Bank of Cyprus on the Cyprus Stock Exchange. The stock likely will start trading sometime in early 2014. This could be an excellent opportunity, since many ex-depositors are likely to “hit the bid” and be done with their misadventure. Owning a country’s premier bank—especially after it’s been chastised by a near-death experience—can be a profitable speculation.
For other specific stocks trading on the Cyprus Stock Exchange that would make for great speculations, and how to access them from your living room, I’d recommend that you check out a report I co-authored with legendary crisis investor Doug Casey. It’s titled Crisis Investing in Cyprus and you can learn more here.
Nick Giambruno recently co-authored a report with Doug Casey titled “Crisis Investing in Cyprus.” Nick has a long-held passion for internationalization. He has lived in Europe and worked in the Middle East. Nick is a CFA charterholder and holds a Bachelor’s Degree in Finance, summa cum laude. He is the Senior Editor at InternationalMan.com.
