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

30 Apr

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

  • 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.

Continue reading this story from the original source, Seeking Alpha,  here.