Is Venezuela The Reason For The Recent Weakness In Gold Prices?

April 27, 2015

San Francisco (Apr 27)  •Citigroup and Venezuela have been negotiating a gold swap deal for over a month.

•Last Friday we finally saw closure on a deal between the two parties where at least $1 billion of gold will be swapped.

•A lower gold price favors Citigroup and now that the deal is done we may see some relief for gold.

•In terms of this deal, Citigroup would now benefit from a higher gold price as Venezuela would be forced to buy back its gold at a higher price.

Over the past few weeks gold has been fairly week despite geopolitical issues that would ordinarily provide strong support for the metal. This weakness culminated last Friday as gold hit a multi-week low right before London close (around 10 AM EST).

This puzzled many analysts as gold failed to rally following consistent weaker-than-expected U.S. economic data. We may just have found out the reason for gold's recent unexpected weakness.

The Venezuelan Gold Swap

For a few months Venezuela had been discussing a gold swap with a number of US banks, which last Friday the country closed with Citibank for at least $1 billion US Dollars. Bill Baruch, chief market strategist for iiTrader, said looking back last week's price action now makes sense as forces were trying to keep gold prices low while the two sides successfully negotiated the gold swap. He found it strange that gold had no "mojo", but "Last week, there was a large amount of selling that kept prices low and now we know why," he said.

We completely agree with Mr. Baruch and think that a significant, motivated seller is now out of the market. Why is that?

Our understanding of the gold swap (and details are still a bit scarce) is that based on the initial reports, the central bank would provide 1.4 million troy ounces in exchange for cash. After four years, it would have right of first refusal to buy the gold back. Of course, during this whole time the Venezuelan central bank would be paying interest to Citibank on the borrowed money.

So it would be in Citigroup's benefit to have the lowest possible gold price going into the deal (remember most of these deals are closed based on the London Gold Fix), which we did see very clearly last Friday as gold plummeted into the London close. Investors should remember that the lower the gold price, the more ounces of gold Citigroup gets for its $1 billion (or more) that is loaned to Venezuela. Once the swap deal is done, it would offer no more benefit to Citigroup to see a lower gold price, and in fact, it might be of greater benefit to see a higher price as they now have the Venezuelan gold.

In addition, this deal may reflect Citigroup's view of the future as it suggests the bank is bullish on gold as they would greatly benefit to see gold rise as they now have $1 billion of physical gold that Venezuela may have to buy back in a few years. If that gold price was much higher than Citigroup would be earning interest income from the loan plus the price appreciation on their gold holdings. A pretty sweet deal if you believe in higher future gold prices.

Conclusion for Investors

While there is no certainty that this deal was a big reason for the weakness in gold over the past few weeks, we do believe there is a good possibility that it was.

This simply adds another reason to the many reasons that we believe investors should own gold despite the lack of mainstream interest in gold. Thus we think this is a great opportunity for investors to accumulate physical gold and the gold ETFs (SPDR Gold Shares (NYSEARCA:GLD), PHYS, and CEF) - though be very careful as ETF's work well in certain circumstances, but in others physical gold is much more desirable and investors should own both. For investors looking for higher leverage to the gold price, they may want to consider miners such as Goldcorp (NYSE:GG), Newmont Mining (NYSE:NEM), Agnico Eagle Mines (NYSE:AEM), or even some of the explorers and silver miners such as First Majestic (NYSE:AG) or Pan-American Silver (NASDAQ:PAAS). We're not suggesting these companies specifically (though we did recently issue a piece detailing our top five gold picks for 2015) - only suggesting them for further investor research. Investors interested in the miners may be interested in taking a look at some of our investment thesis detailing some of the rules we're currently looking for in a gold miner.

Finally, we think the real opportunities will be in the gold explorers, as their valuations are much lower than the miners and the fact of the matter is that these gold miners will be looking to expand reserves and buying out the quality explorers, so we'd suggest investors be aggressively investing in these quality explorers. For those interested in explorers or investors interested in keeping up with the gold market on a consistent basis consider following us (clicking the "Follow" button next to my name) or join our free email list where we send out a weekly email summarizing all the important events in the gold and silver industry, including all of our latest articles and research - it's a great way to keep up with the gold and precious metals market whether you are an individual investor or economist and its completely free.

Investors need to remember that when it comes to gold there are many players that operate privately to drive prices up or down. Understanding this and being able to focus on the bigger picture is key to being able to maintain a position that has performed rather poorly over the past few years. This latest deal may take a bit of weight off of gold's shoulders and provide the foundation for a bullish move up.

Source: SeekingAlpha

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