Tuesday, January 12, 2010

Not a Prophet in Venezuela

Analyzing Venezuelan bonds as an investment is a very sticky topic. On one hand, it’s very hard to be dispassionate about the issue, given the fact that I spent so many years in the country. On the other, there’s potentially good money in it, so one has to be practical and try to leave one’s emotions aside.

I will start with some advice: if you live in Venezuela or conduct a good amount of business there, you should probably NOT invest in Venezuelan bonds. Doing so would violate Dalmady’s first law of portfolio diversification: “Never put you nest eggs in the same basket as your cojones”. While this law may be a slight contradiction to Lynch’s axiom: “Invest in what you know”, ask any Enron ex-employee, who found himself simultaneously jobless and penniless (their 401ks invested in Enron stock), which precept is the more important one.

This is not to say one shouldn’t participate in the opportunities for participating in new offerings and quickly flipping these bonds for a profit, many of which have been good trades in the past few years. Those are arbitrages though, not really “investments”.

As for the rest of you (or us…but mainly you), here’s my take. Veni bonds have been on a tear lately, as you can see in the graph below of the benchmark Ven 27 bond (click on it to get a larger picture). In the last 30 days, that bond is up from 67% to around 83%.

There are a few explanations for this. First of all, Venezuelan debt was lagging in the credit market rally that began in late 2008. And it was lagging so badly that it was surpassed by the likes of Argentina and other lesser credits (not mention countries like Georgia, El Salvador, etc…which enjoy still much much better credit terms).

That fact wasn’t lost on the analyst community, which picked up on what they believed to be a bargain. Deutsche bank issued a note with a buy recommendation on PDVSA bonds several weeks ago and other analysts also gave their nod to Veni bonds. An analyst I spoke to at Credit Suisse was also very bullish on the bonds (while I shook my head in wonder). Analysts cite indicators, such as a relatively low Debt to GDP, Export Volumes, Substantial FX reserves, etc…which all seem to point out that Ven debt wasn’t as bad as its market price was indicating.

After Friday’s devaluation, even S&P got in the act, revising Venezuela’s credit outlook to “stable” from “negative”. JP Morgan upgraded the bonds yesterday also. So there is a lot of momentum riding on this trade and it could tick up even higher from here. If you’re riding this wave, congratulations, if you’re looking for some action there may still be some here. Double-digit yields are becoming an endangered species in the credit world and Venezuelan bonds still offer those.

Longer term, however, caution is the word. Although it’s hard, if not impossible to be a hometown prophet, I must point out the danger, Will Robinson. Buying Venezuelan debt is like lending money to a wealthy, eccentric and partly insane uncle. You kind of figure he’s good for it, but there’s a good chance he’ll blow his fortune buying real estate on the moon or something and leave you hanging out to dry.

That is the kind of uncertainty you must deal with if investing in Venezuela. Chavez regime’s economic policies are entirely idiot-logical (i.e. only make sense to an idiot). Electric shortages are fixed by shutting down shopping malls, agricultural policy proposals include “vertical chicken coops” on rooftops in poor barrios and consumption of scarce products and services is dissuaded by keeping their prices low. If money is tight, just take some dollars from the reserves at the Central Bank and/or devalue. What’s more, when devaluing the currency, book an exchange gain and spend that, too. What? still not enough? Nationalize a bank or two or ten. Ponzi banks? Bail them out and take them over. Need more money? That’s why we have the “Casa de la Moneda” (currency printing plant).

Corruption, deliberate misinformation and ineptness merge together to form an incomprehensible mess. There isn’t an official figure that can be trusted without an independent third-party verification. Inflation, unemployment, sure every country plays with those numbers…but also more basic, fundamental numbers are suspect in Venezuela. The “embellishment” of oil production figures has been well documented. But it could go deeper still. For example, the Central Bank puts FX reserves at $35 billion. Really? I’d need to see every single greenback to be convinced that that is the case. (Who audits the BCV? Think about that.)

I know what some of you may be thinking: “Dalmady’s just another Chavez-hater who wants the Venezuelan economy to fail and Chavez to fall with it”. Nah. I’m afraid Chavez is a given, he’s not going away anytime soon, so I’d much rather the country did well than not. Less than a decade ago, Brazil was considered a greater credit risk than Venezuela. Now it’s “investment grade”. Venezuela, on the other hand, competes with the worst of the worst. It’s disappointing, sad and no “trend change” is in sight.

It’s not like analysts aren’t used to uncertainty and contradiction, especially when dealing with government policy. Sure, measuring risk vs. expected return is how we handicap the game. In the case of Venezuela, IMO, there are just too many unknown variables and possibly disruptive scenarios to make an educated estimate. Expect the unexpected would have to be my best assumption. How do you put odds on that?

So, invest and play the game of chicken with fate, hoping to be able to bail out before the inevitable collision (Oh, yes…it WILL happen) or sit on the sidelines just for the satisfaction of watching the accident and saying “I told you so”. You could be waiting a long time for your shot at schadenfreude.

It’s a lose-lose proposition. I prefer to play some other game.


  1. wow, Otto wasn't exaggerating. 'top stuff' indeed. thanks Alex.

  2. I agree with practically all you say, just a couple of interesting tings to add:

    1) One of the reasons why the Venny bonds were yielding so much was that foreign investors were more worried about the Government coming to market with more bonds, that about default risk. As a large fund manager told me: "I like Venny at 12% and I like Venny at 25%, I just will not buy it if the Government can issue another US$ 11 billion in the next six months". With the devaluation investors feel that with the fiscal gap closed from 12% to 2% thansk to the devaluation, there may no new issues until the fourth quarter.

    2)I actually owned PDVSA 14's, the short end of the curve that has a coupon. The main reason was the large difference (400 basis points) with the Venny '14's. The second reason was that I was expecting a devaluation, never as large as the one announced (That alone tells you things are worse than it looks). I am holding on to them for a bit, because I think they will rally further, but more importantly, the probability that PDVSA will relax the conditions for partnership in the heavy oil fields has increased. If it happens, it will be give us another large rally, particularly on the PDVSA bonds.

    It will then be time to sell and come back in a few years. (Disclosure: I did not own any Venny from 2000 until 2008, had the oil partnerships Petrozuata and Cerro Negro only)

    Graet work as usual, wish you would post more often, people at work enjoy your writings!

  3. I really like the idea of 14% or even 25% yields, but so did the people who invested with Madoff, or Stanford, or someone like them. But then one could like the idea of playing craps and doubling your money. Or not.
    Grinding my teeth and cursing, I finally bought a 0.55% cashable GIC, knowing it was 'insured' by the Canadian government. I put 'insured' in scare quotes because I don't really trust anyone, and it seemed 'safer' than just leaving an extra hundred grand in my online trading account. Trading accounts are not 'insured'. God, do we have to qualify everything? And is the only really safe place a hole in the ground?


    January 12, 2010 7:59 PM

  4. I care not about Veni bonds; but I arrived for a read on Otto's reco.

    My word, sir, what a pleasure it has been to read this post. I love the examples of idiot-logical policies and the metaphor of the wealthy, eccentric and partly insane uncle.

    Thank you.

    And, belated kudos also for your role in outing Allen Stanford...



  5. Of Interest: http://www.washingtonpost.com/wp-dyn/content/article/2010/01/24/AR2010012402379.html?hpid=opinionsbox1