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Thursday, February 6, 2014

What Is Goldman Sachs Doing With Venezuela's Gold? - Bloomberg

What Is Goldman Sachs Doing With Venezuela's Gold?
By Matt Levine - Nov 25, 2013 

A while back Greece had a problem. The problem was that it wanted to borrow more money, but didn't want to increase its debt. (Because the European Union would frown on it having more debt.) So it went to Goldman Sachs, and Goldman told Greece, well, what you can do is borrow some money from us, but we won't call it debt, because something something something something swaps.

This worked pretty well for everyone, for a while: Greece got the money, but nobody outside the deal understood that it had borrowed the money, because it was part of a derivative trade that was not accounted for as debt. Then it stopped working, and everyone got mad at Greece for disguising its debt, and at Goldman for helping Greece disguise its debt and charging rather richly for the service.

Goldman Sachs Group Inc. (GS) Vice Chairman Michael S. Sherwood said his firm would refuse another deal like the derivative it sold Greece that masked the nation’s growing debt to help it meet European Union standards.

“We absolutely wouldn’t do a transaction like that today,” Sherwood, 48, said in an interview posted on Channel 4’s website yesterday in London. “There have been transactions of that ilk that have been presented to us by other European sovereigns that we’ve turned down because we felt there wasn’t the appropriate transparency surrounding them.”

I cannot entirely agree -- I'm sort of of the school of "if it's legal1 and it pays you a lot, you should do it" -- but there's probably a reason Sherwood is giving interviews about reputational risk and I'm a blogger.

But a hedge fund reader points me to an intriguing modern parallel, or at least the rumor of one.2 Venezuela, it seems, has a problem.3 In its foreign currency reserves, where most countries keep foreign currency, Venezuela has a lot of gold, because its late President Hugo Chavez really liked gold and wanted to "move away from the 'dictatorship of the dollar.'" It has rather fewer dollars, and it turns out that if you want to buy goods and services in international trade, dollars are more useful than gold.4 Thus the problem.

The normal way to solve that problem is to sell some gold to someone who has dollars. Then you'll have less gold, but more dollars, and the dollars can be used to buy goods and services. But if you're Venezuela, there are problems with this too. For one thing, it seems like sort of a repudiation of your late president's policies. For another thing, spending down your gold reserves might suggest that you're in a bit of a tight spot financially, which though true is awkward.

Also, gold was worth $1,800 an ounce a year ago and is now worth like $1,240 an ounce, so it feels sort of crummy to sell a bunch now.  

In comes, apparently, Goldman Sachs? Here is a thing that seems to be happening:
Venezuela newspaper El Nacional reported Tuesday that Venezuela’s Central Bank and Goldman Sachs are ready to sign an agreement to swap or exchange international gold reserves with a start date in October 2013 until October 2020.

The negotiated amount is equivalent to 1.45 million ounces of gold, valued at US$1.8 billion at today’s prices, which is to be deposited in the Bank of England with the transfers made directly to Goldman Sachs once delivery times are stipulated. Goldman Sachs will then pay U.S. dollars for the gold.

An adjustment of 10% will be made to the asset value as a hedge in case the international gold market price falls. The annual interest rate will be a combination of dollars with the call BBA Libor equivalent to 8%.
Do you know what this means? I do not (here's El Nacional's version, in Spanish but not significantly clearer), but it would seem to be a margin loan against the gold; i.e. something like:
  1. Venezuela is borrowing about $1.6 billion from Goldman for seven years.
  2. Venezuela is collateralizing that borrowing with gold worth $1.8 billion at today's prices (i.e. it's 90 percent of the value of the gold; that's the 10 percent haircut), and it's posting that collateral somewhere Goldman can get it (the BoE).
  3. The collateral will be subject to margin calls as the price of gold increases or decreases.5
  4. Venezuela is paying about 8 percent a year for this loan.6
So is that a good deal for Venezuela? It depends how you count but it's hard to imagine the answer is yes. I mean: Why would Goldman do it if the answer was yes? There are some other arguments below but that is surely the main one.7
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