Grupo La Colina

Venezuela's Gold Deal With Goldman Sachs

Goldman's Cash-for-Gold Scheme

Joseph Cafariello
Tuesday, November 26th, 2013

Venezuela is in serious financial trouble. Its currency has lost more than 31% of its value versus the USD this year, while the annual inflation rate has skyrocketed to over 46%.

Contributing to its rapidly depreciating currency are Venezuela’s rapidly depleting foreign exchange reserves, which have shrunk by 31% in 2013 alone, from $29.9 billion at the start of the year to just $20.6 billion last week. Meanwhile, its external debt has exploded by more than 12 times in just two months from $182 million in July to $2.19 billion in September, more than quadruple the monthly average of $501 million over the prior 12 months.

With its benchmark interest rate at 15.13%, Venezuela is finding it extremely difficult to finance its operation. Another $4.5 billion worth of foreign currency bond sales were announced last week, with bond rates expected to surpass 16%.

Running out of options, Venezuela’s central bank (BCV) is turning to Goldman Sachs (NYSE: GS) in a measure that can only be described as desperate, which the investment bank is all too eager to take advantage of. The BCV is hiring Goldman Sachs to administer a cash-for-gold loan that seems just as reckless as the government’s spending habits. Though the plan is perfectly legal, its efficacy is being debated, its ethics questioned.

The Cash-for-Gold Scheme

The Venezuelan newspaper El Nacional reported last week that the BCV will deposit $1.8 billion worth of gold with Goldman Sachs as collateral for a $1.62 billion seven-year loan at 8% annual interest. Venezuela isn’t selling the gold, but is merely using it to secure the borrowed money.

Goldman Sachs is then to package a security for the loan, selling shares of the account to investors in the secondary market. Ultimately, then, it is the shareholders of the paper notes who are entitled to the interest payments, while Goldman is paid commissions.

The deal is legal and, on the surface, does seem beneficial to all involved, including Venezuela. Since the gold is not being sold, the nation will get all its gold back at the end of the contract in 2020 – if it can repay the loan, that is. What is more, if the price of gold rises in the meantime, Goldman Sachs will raise additional funds on the secondary market, which Venezuela could borrow if it so chooses. So the country is not sacrificing any upside profit potential from its gold. And the interest rate is about half what it is paying through its bonds.

Exorbitant Demands

But looking at the deal more closely reveals two hefty stipulations. As the first, Venezuela can borrow only up to 90% of the value of the gold it stores with the bank; it deposits $1.8 billion worth of gold and receives $1.62 billion in cash. Why? To protect the holders of the notes in case the value of gold drops. But the consideration to the note holders doesn’t stop there.

As Venezuela’s second obligation, if the price of gold drops more than 10%, the BCV will have to deposit additional gold into the account to raise its value back above the amount of cash borrowed. It is a margin account subject to margin calls. But unlike other margin accounts, this is the only one where you have to deposit more than the amount you borrow.

Equity margin accounts will allow you to purchase stocks on just 50% margin, where you put up just 50% of the value of the stocks you buy and borrow 50% from your brokerage firm. In this case you can borrow up to 100% of the amount you deposit, and are allowed a 50% fall in value before you are asked to deposit additional funds.

Yet many of the more liquid stocks can be purchased with just 30% margin, where you put up 30% and borrow 70%. In this case you can borrow up to 233% of the amount you deposit, and are allowed a 30% fall in value before you are given a margin call for additional funds.

What is more, the interest rate on the borrowed amount ranges from 2 to 5%, depending on the brokerage.

Venezuela, however, is being allowed to borrow just 90% of the deposit it is making, compared to 100% and 233% in common practice. It will then have to deposit additional gold on a drop of just 10% in value, compared to a wiggle room of 50% and 30% in the above standards. And it has to pay 8% interest on the borrowed amount, where most margin accounts charge less than 5%.

And note that these margin requirements are granted to just ordinary individual traders. Venezuela is a nation with the world’s third largest oil reserves. Furthermore, gold is supposed to be the ultimate store of value, and yet it is being treated by Goldman Sachs and the secondary market as being less secure than stocks.

Even a futures account will allow you to purchase a full gold contract on just 5% cash margin deposits, meaning that you can control contracts worth 20 times the amount you deposit. By this ratio, for its $1.8 billion of gold, Venezuela should be allowed to borrow over $36 billion, not $1.6 billion. Certainly, a margin call would be issued on a smaller 5% drop in the gold price. But only a small portion of the $36 billion borrowed would have to be returned to the account to restore the collateral.

The deal being offered to Venezuela demands far too much gold as collateral for far too small a loan. Adding the interest only increases the disparity. While many of the stocks that can be purchased on 30% margin pay no dividend at all, the shareholders of this cash-for-gold deal are receiving 8% annual interest AND they want 111% margin?

The deal, however, might be serving Goldman Sachs’ interests more than anyone else’s, as the gold would be stored in its vaults. Remember all those suspicions about the investment bank overselling its gold several times over, and its recent scramble to replenish its gold shortfall? Well this is one way to get its hands on $1.8 billion worth of gold without even having to pay for it, as the secondary market provides the cash while Goldman gets to keep the gold for 7 years.  Such a deal would benefit Goldman Sachs more than it would Venezuela.

Why Gold and Not Oil

That Venezuela would even consider a cash-for-gold program adds to the suspicions of a gold-grab by Goldman and others. With so much oil within the nation's borders, wouldn't it be more advantageous for Venezuela to offer oil instead of gold? After all, the country produces oil, whereas gold needs to be acquired from the outside.

That is precisely what started the whole mess in the first place – Venezuela repatriated its gold. In September of 2011, Hugo Chavez, Venezuela's eccentric previous leader, in his distrust of the international gold cartel began repatriating the nation's gold held in foreign banks. Within four months, 160 tons of gold then valued at $9 billion had made their way out of international banks to Venezuela.

To get an idea of the impact this had on the gold community, 160 tons is equal to some 18% of the total gold currently held by the largest gold ETF, the SPDR Gold Trust (NYSE: GLD). The recent deal with Goldman Sachs would see the return of 45 tons of gold out of Venezuela back into the gold community at a time when they desperately need it. 

A Nation on its Knees

Making this cash-for-gold deal even more futile is the short length to which it will stretch. As economist José Guerra explains to El Nacional, “La operación de oro persigue darle liquidez al Banco Central de Venezuela en momentos en que están en el límite más bajo desde 2004. Apenas 1,2 millardos de dólares son líquidas en este momento y sirven para financiar 10 días de importaciones.”

Translation: “The gold deal will provide the BCV with liquidity at a time when it is at its lowest level since 2004. Barely $1.2 billion are liquid at this moment, and serve to finance 10 days of imports.”

Do you note the futility? If $1.2 billion lasts just 10 days, the $1.62 billion the BCV will raise from this cash-for-gold deal will last a mere 13.5 days. And for that, Venezuela is being asked to turn over $1.8 billion worth of gold for 7 years and pay 8% annual interest over that entire period.

You can sense Guerra feeling like a hostage as he laments, “La República terminó llevándonos a manos de Goldman Sachs mediante esta operación de hipoteca del oro.”

Translation: “The Republic has ended up delivering us into the hands of Goldman Sachs in this gold mortgaging operation.”

And what an operation it is. Taking a nation already on its knees and asking it to turn over more than is fair collateral to secure a high interest loan. But as the bank keeps reminding us concerning all of its self-serving practices, ‘Hey. It’s legal.’

Joseph Cafariello