Venezuela Nationalizes Gold Industry

As the price of gold appears to spiral continually upward among pervasive fears of economic security, Venezuelan President Hugo Chávez has made wide sweeping policy changes in Venezuela to redistribute gold assets and nationalize the industry. The president of Venezuela has instructed the central bank to repatriate $11 billion of gold reserves held in developed nations’ institutions such as the Bank of England, JPMorgan Chase & Co. (NYSE:JPM), Barclays Plc (LON: BARC), Standard Chartered Plc (LON: STAN) and the Bank of Nova Scotia (TSX:BNS).

According to the World Gold Council Venezuela has 365.8 tonnes of gold reserves, placing it just inside the top fifteen positions on the most recent gold holdings list. The United States tops the list with 8,133.5 tonnes with the world total reserves approximately at 30,700.1 tonnes.

Previously, the country held 211 tonnes of the gold reserves domiciled within Canadian, United States, European and Swiss banks and financial institutions, and the objective is to transfer the gold out of western nations to political allies including Brazil, Russia and China. The threats of a near default by the US government, weakening currency and the European sovereign debt crisis have all combined to influence the decision.

Election motives

With the domestic economy and crime as underpinning topics from critics and supporters, Chávez’s approval rating hovers at 50 percent after almost 12 years in office. Last year, he won a majority in legislative elections, but the opposition secured at least one third of the seats, giving it the ability to block critical legislation and top federal appointments. The results have set the stage for a potentially animated challenge from the opposition for the presidency in 2012.

Increased borrowing costs

Despite relatively high levels of foreign currency and oil revenues, Venezuela is close to the bottom of credit rating agency’s metrics due to political instability and weak macroeconomic policies. There are concerns about the government ability and willingness to pay its foreign debt. Increasing global economic pressures, an overvalued currency, a high dependence on volatile oil revenues all concentrate risk for the country’s broader financial situation.

In the middle of last December, Chávez passed a package of five organic laws designed to finalize the transformation of Venezuela’s economy to coincide with his version of 21st century socialism. He also eliminated a dual exchange rate system and unified the exchange rate at 4.3 bolivars per dollar which was followed up in January with the announcement of a second devaluation of the bolivar within twelve months.

Venezuela already has the highest borrowing costs among major emerging-market countries and will likely retain the low credit rating unless major improvements in political stability and fiscal transparency are reached.

In an interview with Bloomberg, Boris Segura, a New York based strategist at Nomura Securities said that the government might be repatriating gold reserves ahead of arbitration case rulings to avoid an ‘attachment risk’ that could freeze international assets. Segura said “We sense that Venezuelan debt prices already incorporate a sizable ‘lack of transparency’ premium.” The repatriation and diversification of reserves may also obscure any transparency of government holdings, which would have a negative impact for the country’s credit portfolio.

State production

Government policies under the Chávez administration have already placed considerable segments of Venezuela’s economy under national control and he has now focused on the gold industry. In the past the government has quarreled with foreign investment interests that disagreed with limits on how much gold they could export. Last year the country temporarily relaxed restrictions on gold exports endeavoring to stimulate production and take advantage of rising prices, permitting some companies and joint ventures with the government to send as much as 50 percent of their output abroad.

Phoning from Cuba, Chávez explained on state television, “We’re going to nationalize the gold and we’re going to convert it, among other things, into international reserves because gold continues to increase in value…I’m going to approve a law to begin taking the gold areas, and there I count on [the military] because there continues to be anarchy, mafias, smuggling.”

Rusoro Mining (TSXV:RML), largely owned by Russia’s Agapov family, is the only significant gold mining currently in operation in Venezuela. In a press release, Rusoro President and CEO Andre Agapov states that, “We believe the Government’s announcement is targeted toward the many illegal mining operations in Bolivar State that operate without government permits and continue to cause significant environmental damage through indiscriminant deforestation and the use of mercury. Gold produced by these illegal operations is often smuggled out of the country or sold illegally, and the government is now taking action.”

The market has responded relatively well to the Rusoro Mining press release sending the share price 16 percent higher over the previous trading session. Despite gold prices climbing over 25 percent on a year to date basis, the share price for Rusoro has fallen considerably lower, discounting the geopolitical risk in the range of 64 percent. Last year the company produced about 100,000 ounces of gold in Venezuela.

Securities Disclosure: I, Dave Brown, hold no direct investment interest in any company mentioned in this article.