Venezuela learns the hard way: gold not the currency it needs

Every financial crunch teaches a universal truth: ‘liquidity’ is denominated in the currency of one’s living expenses and debt payments. As savings burn through, and cash flow declines, other asset classes become luxuries one can no longer afford. The natural response is to then look to sell (exchange) other assets for needed cash.

The trouble is humans tend to run in herds when it comes to asset collection and notions of value. We have lived through a decade where falling interest rates made people increasingly convinced that cash was trash and other financial assets and tangible/collectable/commodities were most valuable. Product sellers grew fat on the fad.

History assures us that following such periods, notions of value tend to reverse– equal and opposite in the other direction– as a drop in cash flow and/or confidence prompts a desire to raise liquidity.  As tensions spread, a full blown liquidation phase frequently takes hold:  where sellers overwhelm interested buyers, and prices collapse in the process.  Even holders not needing or wanting to sell, are hammered with losses.

The ongoing plunge in commodity prices since 2011, is a classic example of this cycle in motion. The sharp drop in the price of oil is leaving previously over-confident producers in financial shock. Venezuela is one striking example.  With 95% of its export revenue dependent on oil, cash flow is in sharp retreat. But having placed 68% of its international reserves in gold bullion–which has also been falling in value for 4 years and 15% since January alone— Venezuela is learning the hard way that gold is not the currency it needs to pay living expenses and debtors. See: Ravaged by Oil’s collapse, Venezuela now has a big gold problem.

The decline threatens to erode reserves the cash-strapped country relies on to pay its foreign debt…

Venezuela’s dollar-denominated bonds have lost 19.2 percent in the past three months, the most in emerging markets, as the collapse in oil exacerbates concern the nation will run out of money to pay debt. Yields on its benchmark notes climbed past 26 percent on Aug. 6, the highest since February…

Venezuela’s reserves could fall below $15 billion if gold prices fall further or if the government decides to liquidate some of its holdings, according to Sarah Glendon, the head of sovereign research at Gramercy Funds Management.

In April, Caracas-based newspaper El Nacional reported that the central bank swapped $1 billion of its gold reserves for a cash injection. And in 2012, then President Hugo Chavez repatriated most of the country’s gold reserves.

Venezuela has drawn down reserves about $1 billion a month this year to counter the drop in oil prices, Morgan Stanley said in a note to clients last month.

“It’s a question of what weighs more in their mind: servicing their debt or holding their gold in Caracas?” Gramercy’s Glendon said from Greenwich, Connecticut. “It’s going to be extremely challenging for Venezuela to get another source of dollars.”

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