FSO Editorial: "Venezuela's Inflaiton Problem" by Monty Guild 05/08/2007

VENEZUELA'S INFLATION PROBLEM
by Monty Guild
Guild Investment Management, Inc.
May 8, 2007

HUGO CHAVEZ HAS AN INFLATION PROBLEM, AND IS BECOMING INCREASINGLY AUTOCRATIC

Last year, Venezuela’s inflation rate was 17%. This has of course been expected and is what happens when you nationalize a lot of industries. Nationalizations, on a global basis, have historically caused corporate efficiency and productivity to decrease as unsophisticated and unmotivated, politically appointed bureaucrats replace seasoned professionals as the managers of the nationalized companies and industries.

Production slows, costs rise and the profit motive is replaced with the "do less, but still collect the pay" motive. For example, since the nationalization of the Venezuelan oil company a few years ago, oil production in Venezuela has fallen substantially. Many experienced Venezuelan petroleum engineers and geologist have left the inefficient, bureaucratic and corrupt Venezuelan national oil company and moved to jobs in Canada, the U.S., Europe and elsewhere in the oil producing regions of the world.

Hugo Chavez has wasted Venezuela's money in the form of handouts to foreign countries to buy political power and influence in Latin American politics. Now, he is slowly strangling the economic base of his country by nationalizing and threatening nationalizations of many industries including steel, cement and others.

WILL THE LATIN PATTERN REPEAT ITSELF IN VENEZUELA? WE THINK IT PROBABLY WILL

Outside of having natural resources, Venezuela is competitive in nothing. If Venezuela follows the pattern that has been exhibited by other formerly prosperous Latin American countries once they fell into the hands of a demagogue, the outcome will look something like this:
1. Inflation will continue to rise.
2. Chavez will blame the companies who are passing along cost increases, he will nationalize them taking over the assets for a fraction of their true value.
3. He will operate them inefficiently which will lead to further inflation and more shortages.
4. Eventually, the poor who elected Chavez will realize that he did not keep his promises. They will bring in another strong man, who will offer new, but similar programs.
5. The country will careen from one egomaniac dictator to another until all of their natural resources have been eaten up, and their business infrastructure damaged.
6. They will look back in a few decades and see the same type of destruction that has been visited on so many formerly strong Latin nations before them. It is a cycle of power and prosperity to poverty and second class status.

SUMMARY

With Venezuela's recent expropriation of all foreign oil companies’ fields, we look for oil production in Venezuela to continue to decline. Inflation will drive the standard of living down. The educated will continue to leave the country. Therefore, we would avoid all investments in Venezuela.

In a global environment of tight energy supplies and increasing energy demand, we expect oil prices to continue to rise due to Venezuela’s declining production. Also, high inflation anywhere means higher gold demand and higher gold prices, especially in that country.

EVERY DAY IT SEEMS SOMEONE ELSE BEGINS TO REALIZE THE VALUE OF PRECIOUS AND BASE METALS ASSETS

Today, it was Merrill Lynch causing a run up in the price of BHP, the world’s largest mining company, by saying that the company broken into its parts, as a base and precious metals mining company, was worth 34% above the current market price.

Mining is a notoriously volatile business in both directions. Now with global demand for base and precious metals exploding, it is volatile to the upside, and will remain so for many years to come.

We believe strongly that precious and base metals should form a core holding in every long-term investor’s portfolio. I am not talking about day trading stock jockeys. I am talking about serious long-term investors.

Because we are known by other professional investors as global investors who have been involved in metals stocks and foreign stocks for a long time, we get calls from other professional investors asking us about the outlook for foreign stocks and mining companies. We tell them that we remain very bullish on non-U.S. dollar assets including precious metals, base metals and stocks in fast growing countries like China, India, Singapore and others.

It is our impression that more and more professional investors are starting to understand the message and are adding these categories to their portfolios. This can only be bullish for gold, base metals and foreign stocks and bearish for the U.S. dollar.

ASIA AND THE MIDDLE EAST STRENGTHEN THEIR TIES

The Wall Street Journal on May 3rd had a noteworthy front page story entitled "Oil Lubricates Asia-Mideast Ties"

Here are a few main points from the article:
1. The Arab nations of the Persian Gulf, dubbed by the East Asian countries as West Asia, "are spending $270 Billion on new energy projects alone between now and the end of the decade"
2. "Rising East Asian investment in the Middle East could prompt burgeoning powers China and India to take a more active interest in trying to stabilize the region". Decisions in Delhi and Beijing could become as important as decisions made in Washington and Moscow have been traditionally.
3. The U.S. defense shield for the Saudi’s is still an important card for U.S. to play.
4. "two-thirds of all exports from West Asia including Iran and Saudi Arabia currently go to East Asia"
5."The increasing links between the gulf and Asia could have deep geopolitical ramifications... [This] contrasts with the hostility and suspicion between OPEC and the West in the oil-crisis-ridden 1970s."

The Asians have the good economic management [budget surpluses], and demand to create a wonderful market of the Middle East’s oil for a long time to come. The Middle Eastern oil producers know that their bread is increasingly being buttered in Asia not in the West. We look for more alliances between Asians and the Middle East, with the West conspicuously absent.

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