Gold Reserve Inc. (GDRZF)

[Enterprising Investor]

Come Invest In Sunny Venezuela (5/22/16)

Summary

• The idea of socialism is popular in the US

• How is the reality of socialism working out?

• A Venezuelan investment idea to consider

Many Americans love the idea of socialism

What is the appeal? There is much one might love - you can get paid to not work, you can legally take other people's stuff, and you can get credit for generosity with other people's money. It takes the powerful feeling of envy and backs it with force. While capitalism leads to inequality by rewarding good behavior (supplying goods and services that customers want) and punishing bad (you own the consequences of your actions for better and for worse), socialism enforces equality by doing the opposite.

Who wants free stuff? Quite a lot of people. According to current survey data, socialism is especially popular among millennials, the fastest growing minorities, the lower income brackets, and Democrats. While Americans are currently more supportive of capitalism than socialism overall, the fastest growing groups are the most enthusiastic about socialism. White respondents prefer capitalism by 29%, black respondents by 11%, and Hispanics prefer it by 10%. As income falls, support for socialism rises - upper income earners prefer capitalism by 47%, middle income earners prefer it by 36%, and lower income earners prefer it by 8%. People under 30 years old are 11% more favorable towards socialism.

Most Republicans identify as capitalists. Across the aisle, Democrats are twice as likely to identify as socialists than they are to identify as capitalists. Most Democratic primary voters believe socialism has a "positive impact on society". Such Democratic voters view socialism favorably across every age group, race, and gender. They prefer it to capitalism by a 15% margin. Those 45 years old and younger prefer it by a 27% margin. Most agree that the government should take control of certain industries.

How is socialism working in practice?

One place where the ideas of socialism have recently been put into practice is Venezuela. Many socialists in the US have gushed over Venezuelan socialism (see Hugo Chavez's economic miracle, which specifically fawns over Venezuelan crime and poverty statistics). Before I get into the specifics of my long idea in Venezuela, it is worth a look at the empirical evidence of how Venezuelan socialism is working out in practice. As with other country markets that I have invested in including Russia, this is more of a practical than a philosophical question. So, in that spirit, how are things going for socialism in Venezuela?

Venezuela economy shrank by 6% last year and is on track to shrink another 8% this year. Annual inflation is running at over 700%.

The currency has collapsed to the point where the company responsible for running its printing press is refusing to do business with the Venezuelan government. Whereas capitalism uses the price system to connect the supply of good with demand for those goods, socialism uses queuing. In Venezuela, queuing is a big part of daily life.

Queuing has advantages and disadvantages. One advantage is that socialists can describe things as "free". Disadvantages have recently included scarcity of basic staples and violent riots. In the first quarter, the official government statistics indicate 4,696 murders in Venezuela; however, unofficial estimates from human rights monitors are about 55% higher. The capital city of Caracas is now the most violent city in the world with over 120 homicides per 100,000 inhabitants. Morgues cannot keep up on busy nights, so fresh corpses are stacked outside.

Socialism is famous for free healthcare, but hospitals are often without antibiotics, IV solution, and food. Doctors have to contend with power outages that shut down respirators. The president responded by discouraging Venezuelans from using hair dryers,

“
I always think a woman looks better when she just runs her fingers through her hair and lets it dry naturally. It's just an idea I have.

- Nicolas Maduro in response to widespread power outages

In total, the Misery Index, calculated by adding the unemployment rate, lending rate, and the inflation rate, minus the annual percent change in real GDP per capita, indicates that Venezuela is the most miserable place on earth.

Investing in Venezuela

Having reviewed socialism in theory and practice, I would like to make the case for investing in Venezuela. The investment in question is Gold Reserve (OTCQB:GDRZF). I first disclosed this investment in 2014, writing that,

“
Gold Reserve (GDRZF in the US; GRZ in Canada) has a market cap of $248 million and a $740 million award against Venezuela from the World Bank's International Centre for Settlement of Investment Disputes/ICSID. Venezuela is just about the last country you want to owe you money, but this judgment is enforceable abroad including in the US. Venezuela relies on imports and exports and it has some assets such as Citgo that could be vulnerable.

GDRZF equity trades at a deeper discount than does Venezuela credit, despite the fact that ICSID awards survive sovereign default. While it has become prohibitively expensive, in the past one could hedge out a lot of the Venezuelan risk via the purchase of Venezuelan credit default swaps (CDSs).

What is next for GDRZF? On Monday December 15, 2014, the ICSID tribunal reaffirmed the $714 million award. With interest, Venezuela currently owes GDRZF about $744 million. This amount increases by $1.5 million each month. GDRZF is pursuing their award through both French and American courts.

The original thesis was that we would be able to collect the ICSID award. If necessary, we could seize assets in the US. Perhaps we could sell the project data to Venezuela for something. The price was around $3.50 (in Canada); the value was $6-7. Since then, the price has gone to $5.80, but the value is clearer. Venezuela settled, signing a memorandum of understanding regarding both the award and the joint development of the Brisas and Las Cristinas projects. We get an award with interest. We also get a 45% interest in a JV to develop the Brisas and Cristinas properties using Gold Reserve's technical mining data. I had not known exactly what CEO Doug Belanger was up to. Typically I favor simple plans (liquidate and send me my money) but he came up with something much better.

Hedge

I don't think that this investment requires a hedge on either Venezuela (too expensive) or gold. However, there are pricier gold miners such as Coeur (NYSE:CDE) that can be shorted against it. Coeur will keep digging up gold, but they will also keep diluting equity holders towards $0.00 over time.

Conclusion

Socialism is an idea that attracts enthusiasm within large and growing segments of the US. It is also being put into practice in Venezuela with measurable results. Despite problems that include an estimated 100,000 illegal miners, many of whom are members of armed gangs, there could be an opportunity in Venezuelan gold mining via Gold Reserve. While the Venezuelan government is the majority JV partner, this opportunity is not about politics, just business.

What exactly is Gold Reserve worth? Well its JV's locale is certainly deserving of some discount. For political stability and convenience, I would prefer all of my natural resource investments to be located between Gstaad and Lake Geneva in Switzerland. However, I have to go wherever 4.54 billion years of geological history plopped them. But even applying a draconian discount, this idea will probably end up being a double from its original disclosure and a substantial upside from today.

Disclosure: I am/we are long GDRZF.

Additional disclosure: Chris DeMuth Jr and Andrew Walker are portfolio managers at Rangeley Capital. We invest with a margin of safety by buying securities at discounts to their intrinsic value and unlocking that value through corporate events. To maximize returns for our investors, we reserve the right to make investment decisions regarding any security without notification except where notification is required by law. We manage diversified portfolios with a multi-year time horizon. Positions disclosed in articles may vary in sizing, hedges, and place within the capital structure. Disclosed ideas are related to a specific price, value, and time. If any of these attributes change, then the position might change (and probably will).

Stocks: GDRZF, CDE

http://seekingalpha.com/instablog/957061-chris-demuth-jr/4884349-come-invest-sunny-venezuela