Spinning the wheels won't work when there's capital flight

We have seen some troubling developments as capital is now fleeing Greece and this is also spreading to Spain. Bankia SA, now owned by the Spanish Government (from last week) is down more than 29 percent after the major Spanish daily El Mundo today reported a loss in excess of 1 bn. EUR of deposits (since May 9!).

This is the full reuters piece: Banks clients pull out over 1 bln EUR

Other commentators have also commented on this concerning increase in capital flight. The Daily Telegraph's Ambrose Evans-Prichard: Debt Crisis: Greek euro exit looms closer as banks crumble.

We have gone from a situation where no-one publically wanted to talk about the Greek exit to one where we everyone is making plans for the re-introduction of the Drachma. The path from here is very uncertain - in other words the tail-risk is massive, and we will see lots of extend-and-pretend over the week-end with the G-8 meeting and politicians finally realising they called off the crisis way too soon.

One is increasingly reminded that this looks, acts and smells like the final move towards Japanisation of the EU.

The worst case scenario is being spelled out in this piece from the Guardian: Cost of Greek exit from Euro put at 1 trillion US Dollar

Let me show you two charts that concern me:

Market Itraxx Europe Senior Financial Index (basically the health of European banks - the higher the rate, the worse the perceived default risk)

The second one is risk-reversal on the EUR vs. USD. It's how much extra a EURUSD put costs relative to a EURUSD call - the more negative the so-called skew, the more fearful the market is of the asymmetric downside vs. upside risk to the currency pair. This indicator is sometimes predictive ahead of major turning points. It turned before the LTRO introduction in December, for example, indicating exhaustion of Euro bearishness/US dollar bullishness ahead of the stock market lows, and now it has turned sharply lower and is through its long-term average, indicating US Dollar hoarding.

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From a very short-term perspective the market is oversold - mainly in commodities. I would recommend building positions slowly long GOLD from here. (Check this post I did a couple of days ago: Gold - risk reward attractive)

Strategy
I continue to have 50% US dollar, 25% in both SEK and NOK as currency exposure. Net short AUD/USD, and long USD/CAD.

I have 50% in high quality corporate bonds, 5% in tail-risk options (down from 25% - due to profit taking and oversoldness), and finally 45% in cash.

The protest phase of this crisis could be nearing its more climactic part, in which the market tumbles and politicians/central bankers again will respond with indications of further QE.  The fact Gold is up on a major down day for stocks and risk tells me two things:

1. More QE is increasingly being priced in.
2. The easy "short" trade is now more difficult to manage - I will play it more and more with buying 20-30 delta puts rather than cash, having reduced my tail-risk protection from 25% to 5% I have some premium to spend.

Finally, always remember, when the noise is loudest the valuation is cheapest - this is not going to be a one-way street to a new low, rather it will be the usual: false starts stimulated by rhetoric and no real meaningful action. Japanisation as the next macro theme looks to be the odds-on favourite for this grey haired trader.

For more see this CNBC interview I did this morning on risk, banks and macro: Risk-off again amid Euro Zone Political Turmoil?

Safe travels,

Steen