Implications Of Venezuelan Gold Repatriation

Includes: GLD
by: Gregory Hines
In light of the wild gyrations in the price of gold the past few weeks, I thought it might be helpful to elaborate on the Venezuelan repatriation of gold two weeks ago along with other aspects of the deal that did not receive as much attention.
Two weeks ago, President Hugo Chavez of Venezuela announced that he would repatriate roughly 211 tons of gold bullion to the Venezuelan central bank in Caracas. Of the 211 tons, 99 will be taken from the vault of the Bank of England and the rest from the New York Fed and various banks (JP Morgan, Barclays, Standard Chartered, and the Bank of Nova Scotia). In addition to this move, central bank president Nelson Merentes stated that Venezuela will be exchanging $6.2 billion worth of U.S. dollars for other currencies, notably the Brazilian real, Chinese yuan, and Russian ruble. The funds are currently held in banks in Switzerland, France, and the United Kingdom.
To understand the financial implications, we must consider the motives for such a brash move. It could be agrued that, in light of the events in Libya, Chavez is worried about the freeze of assets in the context of a future confrontation. Although this may have played some role in the decision, I believe an economic, not political, motive was the impetus for the move. With the Federal Reserve’s easy money policy of the last two years, the eurozone debt crisis, and the economic woes in developed nations, diversification into emerging economies with better growth prospects would be a prudent move for any investor, including sovereign nations. The sentiments of Merentes seem to support this argument.

We are protecting our fund, in a first phase. If there is a region affected by an economic disturbance, the most prudent and advisable decision is to change the location of these reserves .… We are protecting ourselves from the risks our contagion. We seek better safeguard for the funds.

In the past year, the U.S. dollar has declined significantly against the yuan, ruble, and real.

The move comes at a time when other central banks have been buying gold as well. Central banks have been net purchasers of gold. According to statistics from the World Gold Council, Russia, Thailand, South Korea have been the most recent buyers of gold. Bloomberg has also reported that central banks are considering holding gold to manage the debt crisis. Both China and Venezuela have nationalized their gold industries.
The situation seems somewhat similar to Richard Nixon’s decision to close the gold window when French president Charles DeGaulle requested gold in 1971. Large trade deficits and a rapidly depreciating dollar call into question the dollar’s status as a world reserve currency. What followed were years of persistent inflation and gold reaching an all-time high in 1980.
While this may not be what sends gold surging parabolically, it may not be long before another large player comes in and puts a serious squeeze in the physical market that sends a ripple effect through the highly leveraged, paper-driven world of the Comex and other future exchanges. For years, the paper market has dictated the price of gold, but as gold reasserts itself as a currency, it may not be long before the physical market dictates price.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.