Hibachi0 (91.79)

International Arbitration in Venezeula

May 13, 2011 – Comments (3) | RELATED TICKERS: KRY.DL , GRZ

Having heavily looked into gold companies and recently posting on Timberline Resources (TLR), I have run across an interesting play on gold.

Since 2000, 3 gold mining companies, Vanessa Ventures (now Infinito Gold), Gold Reserve, and Crystallex have been nationalized by the Venezuelan government.  The companies respectively have roughly 12million, 12million, and 17 million oz of gold.  All three have filed for international arbitration with the World Bank.  

Because their best projects have been nationalized, each stock has been smacked.  However, given Venezuela's history of cooperation in arbitration and Chavez's declaration a week ago that he wants to expand Venezuela's gold mining and to have more than one foreign company mining (the current one being Rusoro), I think that these companies make excellent speculative plays.

Infinito Gold sports a 15m market cap; Gold Reserve, 105m; Crystallex, 48m.  Each has filed for arbitration settlements of 1b, 1.98b, and 3.8b.  It should be noted that Infinito filed when gold's price was years from breaking $1000/oz.  I expect any settlement to take the current price into account - though I do not know why arbitration has taken so long.  While arbitrations rarely settle on 100% of the asked value, Venezuela has shown to pay fairly reasonable settlements as shown with Verizon and AES.  It paid Verizon 85% of the fair value as calculated by analysts.  Venezuela tends to settle arbitration cases in roughly 3 years.  

Looking at these companies market caps and possible payoffs, I think they are substantially undervalued, though they are obviously very speculative and risky in nature.  For the calcuations, I give the companies a $0 value outside of their possible rewards from arbitration.

Infinito Gold: a 1B settlement (non-adjusted), 15m market cap --> Market suggests 1.5% succeeding 

Gold Resource: 1.98B settlement, 105m market cap --> Market suggests 5% succeeding

Crystallex: 3.8B settlement, 48m market cap --> Market suggests 1.2% succeeding

Where succeeding is defined as getting everything asked for in arbitration or the amount to be received as a percentage of the amount asked.

From these we can clearly see how inefficiently the market has priced these companies given Venezuela's history of paying.  If we assume that each company gets only 10% of the amount filed for (a failure in arbitration terms), we are looking at the companies going up 500%, 100%, and 700% respectively. For a full settlement, we are looking at gains of 5000%, 1000%, and 7000%.

It is not difficult to calculate different scenarios with higher percentages and see how undervalued these three companies might be.  The good thing I can say about these companies is that it is unlikely that they are going to rocket off and we have at least 18 months before the first decision is reached.  Because the nature an arbitration case is similar to a drug approval by the FDA, these companies are going to jump discontinuously when the first settlement of the group is announced as they likely will end up receiving the same terms.

Given this scenario, I would recommend investors take a small portfolio and split it equally among the three companies (and Rusoro if you feel so inclined). Let it sit in your portfolio and gather dust.  While I strongly believe that investors have a long time to get into this dance, I fear that Venezuela may settle with one or more of the companies outside of arbitration and the investor will miss the one time jump that happens in parallel with the other companies.  Even if the companies get a 10% arbitration in 3 years, we are looking at annualized gains of 82%, 26%, and 200% - well worth tying up 5-10% of your portfolio for 3 years.