• A version of this post ran on the author's blog. The views expressed are the author's own.
During the last few weeks, Venezuela and [state-owned oil company] PDVSA bonds have rallied sharply, as investors see increased probability of not only a possible political change in the country, but more importantly, change in the way Venezuela’s public finances are managed.
The rally has been stupendous [see graphs in original post], which shows the price of PDVSA’s 2022 bond, which carries a 12.75 percent coupon and which was issued in February of 2011.
The bond described above has shown three distinct periods over the last year. First, there was rally last June, when President Hugo Chavez became sick. This rally stopped from August to November as the European crisis unfolded. Then, the last and powerful leg this year began in January, as optimism all around the world first drove markets up, which was followed by a further move up upon the successful opposition primaries, which then received another powerful push up with the news that Chavez’s cancer had returned and the President had to have an operation.
Chavismo [the left-wing ideology which supports the idea of subsidies for the poor and government control of productive assets like oil] has called the rally perverse. But in the end, the rally is a bet not on President Chavez’s demise, but the fact that if Chavez played a smaller role in the future of Venezuelan politics, the role of Minister of Finance and Planning Jorge Giordani would also be diminished. Because Giordani was, after all, ranked as the worst economic Minister of Latin America recently (link in Spanish).
And ever since Giordani took charge of planning and finance, Venezuela’s financing costs had been increasing and refused to drop. This can be seen in another graph [see original post] which shows the Global 2027 bond from the year 2000 to last week. This bond has been at much higher prices (lower yields) than it is today during Chavez’s tenure, despite the fact that oil prices are near an all time high today.
From 2003 to 2007, this bond rose sharply, as oil prices increased. Venezuela had a relatively small debt and new issues were coming to market slowly and in a manner fairly well understood by the markets. Then came the financial crisis of 2008-2009, oil prices dropped and debt prices went down. During this time, Venezuela and PDVSA began offering ever-increasing amounts of debt to sustain the exchange rate at an artificially low level. Even worse, the attitude towards the same investors that buy this debt has been unfriendly, surprising the market and issuing large size bonds that flooded the market with paper.
Thus, after the yield in the Global 2027 hit near 20 percent during the financial crisis, it had been unable to drop below the nearly 13 percent level until last summer.
The rally has been impressive. The PDVSA 2022, issued in February 2011, which traded at 75 percent in its first day, closed yesterday at 100 percent. That is a 33 percent return on capital to those that bought the first day, to which you have to add 17 percent return in interest, or 50 percent in little over twelve months.
The question everyone asks, is whether this can continue.
Well, as long as there is the possibility of change in the way the country is managed, the rally can certainly go on. While yields may not go down to the levels of 2006-2007, because the country’s debt has increased dramatically over these years, oil prices are higher and Venezuela could be in better shape than other countries yielding 2 percent to 3 percent below Venezuela’s yield. It is, in the end, all relative.
But the ride is likely to be bumpy, as the sell-off yesterday shows, after the violence on Sunday during Capriles’ rally. Investors can scare easily, even if the potential returns can be very attractive. But investors like the yield and this provides some cushion in this bumpy ride.
As usual with investments, it is when to sell that is the toughest to decide.
– Miguel Octavio, a Venezuelan, is not a fan of Venezuelan President Hugo Chavez. You can read his blog here.