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Is Another Black Wednesday Coming for Turkey?

- By Matt Winkler

In a frantic attempt to defend its currency, Turkey is burning through foreign exchange reserves so fast that at the current rate, it'll be flat broke by the end of next month. This is a situation eerily reminiscent of Black Wednesday, Sept. 16 1992. It was on that day that George Soros (Trades, Portfolio) infamously "broke the Bank of England" by heavily shorting the pound. The current situation with Turkey's currency is a bit different, but does create a few interesting investment opportunities in the short term.

According to data compiled by the Financial Times, Turkey's central bank has sold about $10 billion worth of forex reserves in the last three weeks to buy up Turkish lira. It has about $24.7 billion left, or six to seven weeks of reserves at this rate.

The situation was different in 1992 because the Bank of England had to keep the pound within a certain trading range in order to stay a part of the Exchange Rate Mechanism (ERM), a precursor to the European Union. The U.K. had set its exchange rates too high initially and had already printed too much money for the rate that it was aiming at, so speculators, led by Soros' Quantum Fund, sold pounds faster than the Bank of England could buy them.

As history rhymes, the U.K. abandoned the ERM project, and now it is once again on the precipice of exiting the next incarnation of it, the European Union.

In any case, some may be tempted to try their luck by shorting the Turkish lira at this point, assuming that if speculators could overwhelm the Bank of England, lira shorts can certainly overwhelm Turkey's central bank, the TCMB. This is especially true given that the TCMB is quickly running out of reserve ammunition to counter sellers. Shorting the lira may be a decent move for an institution, but retail traders need other vehicles and can't fight a central bank directly.

There is the option of the iShares Turkey ETF (TUR), but it's already skirting lows and has a very low market cap with thin liquidity. There is another option, though, that most do not recognize as related to Turkey, and that is Banco Bilbao Vizcaya Argentaria SA (BBVA). A Spanish bank, it is especially susceptible to a crisis in Turkey and says so in its filings explicitly. According to the bank's latest annual report:

"The Group is particularly sensitive to developments in Mexico, the United States, Turkey and Argentina, which represented 12.86%, 10.67%, 11.43% and 1.35% of the Group's assets as at December 31, 2017, respectively."

So Turkish assets make up this Spanish bank's second biggest segment. In addition, the bank has 21,000 employees who work in its Turkish subsidiaries, the second most employees it has in any country in Europe, behind Spain.

Also according to its latest filings linked above, Banco Bilbao has 9.8 billion euros in sovereign exposure to Turkey, and 9.8 billion euros to Italy as well. Worse, it owns 54 billion euros in the sovereign debt of Spain, whose banking sector has loaned $35 billion to Turkey, more than any other country. This is the financial structure of a doom loop, where banking and debt sectors are interdependent. Turkey and Spain have chained themselves together in this respect.

If Turkey's central bank were to run out of reserves, there could be heavy selling in Spanish banks that would coincide with a devaluation of the lira. Banco Bilbao has an especially heavy Turkish presence, and a trade like this is unlikely to be all that crowded since the link is not generally well known or obvious.

Banco Bilbao also has a daily average trading volume five times higher than the iShares Turkey ETF, and a market cap nearly 70 times bigger. For those interested in shorting Turkey with the lira in danger of collapse, Banco Bilbao would be a straightforward way of doing it.

Disclosure: No positions.

This article first appeared on GuruFocus.