A Gold(en) Opportunity? The State Is Back
The rush to gold as a safe haven has triggered endless articles and comments on the soft, shiny metal, its nature, and its value limits. How high? How low? Clearly, the discussion has been dominated by demand for gold in times of inflation and rising uncertainty.
The supply, however, deserves its own attention. Not only investors flee to safety in the form of gold these days. Governments from gold mining states struggle to keep the wealth of gold and distribute its related income fairly and equally. It was last week when Venezuelan President, Hugo Chavez, reminded us of the importance of supply. President Chavez officially nationalized the gold industry by taking private mines public. Those who follow his presidency are not that surprised. The recent news on gold nationalization should be understood in the broader context of resource nationalization in Latin America, as well as in the Venezuelan context, particularly in the last decade. Chavez had already nationalized the oil and gas industries in the past in order to redistribute the income resulting from the production of various commodities. What’s behind this new wave of nationalization and what are the short and long term consequences?
Nationalism is perceived as a weapon of last resort, seeing as governments have other options for obtaining the same goal. For instance, governments can increase their revenues from natural resources by increasing taxation or royalties. They can also ask for greater participation in corporate decision making. In Russia, where the governmental reputational risk is high, the government keeps long term contracts. Yet, most governments pursue full blown nationalization. A recent UCLA study shows that 80% of oil-producing countries have nationalized their industry over the last century.
Can corporations and their investors predict which country and industry is next? The oil sector experience showed us that price shocks, lack of democracy, and geological complexity are some of the leading factors behind the nationalization decision. Gold miners may follow.
Resource nationalization has a much broader effect than the mere redistribution of wealth or increasing the volatility of a resource price. It changes the country’s business and political landscapes. First, nationalization can be a reflection of a new foreign policy towards the home state of the nationalized corporation or lead to a diplomatic crisis between the home and host states. We should remember that in the good old days (and even today in some parts of the world) the main remedy available for foreign investors is diplomatic protection. The two of the biggest foreign-owned gold mining companies in Venezuela are Canadian, calling for a greater scrutiny of Canadian companies in Venezuela and Venezuela-Canada relations in general.
Second, a weak judicial system and lack of contractual protections, such as a stabilization clause that prevents regulatory changes, leave foreign investors with very limited options. World Bank international arbitration, which has been developing quickly in the region in recent years, has been denounced by countries like Bolivia and Venezuela. Foreign investors, experiencing sunk costs, can be left with the option of renegotiating existing contracts and joint-production with the government.
The shares of mining companies tend to rise in time of a resource boom. That is the case of gold mining companies in light of the current gold boom. When the price of Gold went down earlier this week due to bigger appetite for risky assets – the gold mining industry quickly reacted and went down with it. Yet, in my opinion, the political risks associated with the industry (and other resource-oriented industries) are not necessarily priced properly. It’s time to get the discussion going.
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