Venezuelan bonds — could the rally fizzle out soon?

April 29, 2011

Could it be time to sell Venezuelan dollar bonds? With oil prices hitting new highs, debt issued by the energy-rich Latin American state have been a sizzling favourite with investors this year,  who have been lapping up the 14-16 percent yields. Anyone who bought Venezuelan bonds at the start of this year would have earned a 6.4 percent return versus the 2 percent earned by the EMBIG emerging bond index.  

But JP Morgan this week told clients it was cutting its overweight position on Venezuela. It seems like a good time to take some profit, the bank reckons, especially with an election looming and some worrying headlines of late.

President Hugo Chavez will seek re-election in 2012 and has begun to increase government spending. Venezuela’s inflation rate is already one of the highest in the world. A new windfall tax on oil companies will hit capex spending. And the country may have to pay up to $7 billion to settle cases brought against it by international oil firms that had assets seized  during a past nationalisation campaign, the bank says. 

Worse still, the country’s central bank posted some sobering data  recently, JP Morgan points out. The data showed that despite bumper oil earnings, Venezuela’s hard currency reserves are at $25.8 billion, their lowest since August 2007.  That’s down $3.6 billion this year.  Especially worrying is that just $6.2 billion is in hard cash and the rest is in gold.

“We expect the news flow over the coming months to continue to turn more challenging for bondholders.” JP Morgan analysts write.

Many will argue that it is precisely because of all these risks that Venezuelan yields are so high.  Barclays for instance says it remains bullish on Venezuelan debt, noting oil export earnings will top $90 billion this year — $16 billion more than originally expected.

Oil in fact is the key. Fund managers like to point out that President Chavez paid his debts when oil prices were languishing at $11 a barrel in 1999. He can hardly fail to do so when they are at $120 a barrel.

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