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  1. 1. Global Emerging Markets Venezuela 22 February 2012Macro EM Trade Idea Strategy Update Research Team Venezuela: A Potential Game Fernando Losada Global Markets Research Economist (+1) 212 250-3162 fernando.losada@db.com Changer Hongtao Jiang Strategist (+1) 212 250-2524 hongtao.jiang@db.com In Venezuela, President Chavez confirmed the deterioration of his health outlook. We believe this development could have a negative impact on his chance for reelection. In addition, it also suggests that the scenario in which President Chavez is not able to run for office has to be considered seriously again. President Chavez own confirmation that his recovery suffered a setback alters the political dynamics ahead of October 7 presidential elections. The news prompted a sharp rally across Venezuelan assets, but we believe a positive re-pricing of the curve will likely continue. Given that, we retain an overweight recommendation to the Venezuelan complex, having tactically taken profit and reduced to neutral a couple of weeks ago on supply risk and then reportedly improving health condition of President Chavez. Predicated on a bullish scenario, we recommend investors focusing on bonds that will likely offer the best market to market gains, rather than a lowers loss at default or attractive carry/vol. At the same time, we would avoid bonds that are proximate in maturity to where issuance will likely hit. We maintain a slight bias in favor of PDVSA over the Republic despite the significant outperformance of the former, as the bullish backdrop and higher supply risk on the Sovereign bodes well for continued tightening in the spread differential between the two curves. On Venezuela, we favor a combination of 7% 18s and the old benchmark 27s – the former offering comparable spreads as longer duration bonds but no supply pressure, while the latter offering superior liquidity and a long duration. On PDVSA, our analysis in the recently published article EM Trade Idea: PDVSA - Still a Broken Curve still holds: we continue to favor the high-priced bonds in the mid-section of the curve – especially the 17Ns. Emerging Markets Deutsche Bank Securities Inc. All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 146/04/2011.
  2. 2. 22 February 2012 EM Trade Idea Venezuela: A Potential Game Changer President Chavez confirmed deterioration of his health problems… On Tuesday, February 21, following a flurry of media reports, President Hugo Chavez made an appearance in Barinas State to acknowledge that he had been in Cuba during the weekend for a medical check-up. He admitted that the team of doctors in charge of providing medical care found another “small injury” near the pelvic area where a malignant tumor had to be extracted from last year. Chavez initially said the doctors were determining whether he has to undergo another surgery and, if so, where would it take place. By Tuesday evening, he admitted that the surgery would be conducted very soon in Cuba. Venezuelan asset prices started to react early Tuesday after Nelson Bocaranda, the journalist from El Universal newspaper who first reported early in 2011 that Chavez was seriously ill, wrote in his blog that the President’s health had deteriorated and that he had flown to Cuba for treatment. Chavez stopped short of providing additional details about his illness, but indicated that there has been no metastasis of the tumor. …which may impact his chance of reelection. Chavez’ admission that he needs further treatment does away with his recent claim that he was “completely free of any illness”. The more intense the public’s perception that the President is not healthy, the more negative the impact on his chances of reelection is likely to be. After Chavez had indicated that he was fully healthy and cancer free, he restarted his weekly televised show, and he made a lengthy presentation at the National Assembly, recent polls showed that over 80% of the population believed that he had recovered. But those figures are likely to change now, which could impact his standing in the presidential race. On Tuesday, Chavez acknowledged that it could not be ruled out that the new tumor was malignant, and that the intensity of the treatment he will be subjected to suggests that he will have to retire from the public eye “for several weeks”. He vowed to discuss future steps with other members of his administration. This confirms that Chavez’ ability to campaign aggressively ahead of the October election will be imperiled, thus fueling expectations of a political regime change. While Chavez may well benefit from voter sympathy in the very short term, further uncertainty about his health is likely to have a negative impact on his chances for reelection. The opposition appears to have the right strategy The timing of the announcement coincides with the boost that the opposition will probably receive in the polls after the successful primary election of February 12, when former Miranda State Governor Henrique Capriles Radonski became elected as the presidential candidate of the unified political opposition with some two thirds of the votes. Immediately after the primary election, Chavez had begun to launch verbal attacks on Capriles, whose campaign appears to be focusing on policy problems and possible solutions while carefully avoiding any personal attack on the President. Capriles has vowed to maintain the social safety network created by the chavismo, making it more efficient, and to gradually dismantle the various controls and regulations imposed on the economy over the last few years. The strategy is geared to become an appealing candidate not only for the anti-chavista voters but also to those currently in the middle of the political spectrum. After Chavez’ admission that he required additional surgery, Capriles wrote on his Twitter accounts “to my competitor, as a son of God that I am, I wish a successful operation, a swift recovery and a long life”. Alternative election scenarios have to be considered seriously, again The news suggests that the scenario in which Chavez is not able to run for office has to be considered seriously again. If he is unable to recover on time to campaign and to compete in October 7, the chavismo would have to select an alternative candidate. Chavez himself will probably pick his successor from a small menu of presidential hopefuls that could include his brother Adan Chavez, Foreign Affairs Minister Nicolas Maduro and National AssemblyPage 2 Deutsche Bank Securities Inc.
  3. 3. 22 February 2012 EM Trade Idea Chairman Diosdado Cabello. As per Art. 229 of the Constitution, Vice President Elias Jaua cannot run for President in October. Recent polls show that none of those candidates have a substantial popularity backing, but that could change after the chavista political machinery is put to work in support of the successor. Constitutional rules about succession Art. 230 of the Constitution establishes that the presidential term lasts six years, and that the new term starts on January 10. That is, although there is some leeway regarding the election date, the new President has to be in office by January 10. Art. 233 deals with the succession in the event the president is impaired to fulfill his role. If the President becomes impaired or passes away after being elected but before taking office, a new election has to be called within 30 days of the event. In the meantime, the Chairman of the National Assembly becomes acting President. If the President becomes impaired or dies during the first four years of his/her tenure, the Vice President becomes acting President and has to call elections within 30 days from the event. If the President becomes impaired during the last two years of his /her term, the Vice President becomes acting President until the end of the regular period, and the elections are to take place as normally scheduled. If the President is “temporarily absent” for up to 90 days, the Vice President takes over the Presidency until the former’s return. If the President remains absent after 90 days, then the National Assembly has to determine whether the absence has to be deemed as permanent in order to activate the mechanisms described above. Strategic recommendation - overweight While we hold the Venezuela complex as a strategic overweight in 2012, we recommended tactically taking profit and reducing to neutral on 10-Feb in light of increasing risk of issuance as well as political uncertainty. At that time, President Chavez health condition was reportedly improving. The recent revelation on President Chavez new health concerns should be considered as a game changer in our view. The news prompted a sharp rally of Venezuelan assets yesterday and (again) today, but we believe a positive re-pricing of the curve will likely continue. Even though we continue to believe the supply risk is increasing, a potential political regime change will probably offset any such supply pressure. We recommend now taking an overweight exposure to the complex, and characterize our view as bullish with a certain level of cautiousness. In the event that President Chavez steps down, or announces that he will longer run for office, we believe credit spreads will react very positively in the short term. However, we also believe that the political transition that would ensue will likely be difficult, and possibly very noisy. We believe Venezuela bonds spreads have the potential to trade through their Argentine counterparts in the near future, and this would suggest some 200bp further upside on top of Argentina. We favor cash to CDS and maintain a slight bias in favor of PDVSA While we expect bond prices to rise across the board if our baseline bullish scenario materializes, asset selection remains important to maximize potential gains. Predicated on a bullish scenario, we recommend investors focusing on bonds that will likely offer the best market to market gains, rather than a lowers loss at default (low priced bonds at the very long end) or attractive carry/vol (short maturity bonds). At the same time, we would avoid bonds that are proximate in maturity to where issuance will likely hit. In addition, we continue to believe cash bonds will be the best assets to express a bullish view given the very negative levels of basis, despite that we have recommended taking profit in our long basis recommendations earlier this month on supply concerns. While Venezuela CDS spreads are already tighter than Argentina, bonds spreads remain significantly wider. PDVSA bonds have strongly outperformed their counterparts in the sovereign curve during the recent rally, given their higher betas, and - more recently - on speculation that the market will likely see fresh supply of sovereign bonds sooner than PDVSA (though the latter willDeutsche Bank Securities Inc. Page 3
  4. 4. 22 February 2012 EM Trade Idea likely be the bigger issuer throughout 2012). The spread differentials between the two curves are now at historical tights. However, given the bullish backdrop, we see potential for some further tightening in the spread differential, and as such we maintain a slight bias in favor of PDVSA over the sovereign. We continue to favor the 17Ns in PDVSA… Regarding PDVSA, our analysis in recently published article EM Trade Idea: PDVSA - Still a Broken Curve still holds: we continue to favor the high-priced bonds in the mid-section of the curve – especially the 17Ns. While the local law bonds (the 14s – 16s) may tighten further relative to the global bonds, they are not materially cheap to the 17Ns. A the same time, even though the 22s and the newly issued 21s also look cheap to the curve, we will likely see more supplies on these bonds from the locals. … and a combination of 7% 18s and 27s in Venezuela On Venezuela, we recommend a combination of the 7% 18s and the benchmark 27s. The 18s offer a comparable spread as the longer maturity bonds on the curve and will likely not as much affected if sovereign issuance comes. We believe Venezuela will likely sell bonds with maturity longer than 10 years. While the duration for the 18s may be a little short for providing superior capital gains, the inclusion of the 27s will help offset this shortcoming. Despite that the 27s remain substantially expensive to the curve, its richness has significantly reduced over the past year (second graph below). In addition, we favor the superior liquidity offered by the 27s, which is valuable especially considering the substantial risk of volatility arisen from potential political instability.While Venezuela CDS is flat to Argentina, bonds Venezuela 27s are not as expensive to the curve as theyremains significant wider used to be VEN27 Richness 50 0 -50 -100 -150 -200 2-Feb-10 2-Aug-10 2-Feb-11 2-Aug-11 2-Feb-12Source: Deutsche Bank Source: Deutsche Bank On the following page, we provide tables and graphs for a snapshot of current valuation, recent performances, and CDS/bond basis measures for both Venezuela and the PDVSA curves.Page 4 Deutsche Bank Securities Inc.
  5. 5. 22 February 2012 EM Trade IdeaValuation Report of Venezuelan and PDVSA assets EM Venezuelan Relative Value Monitor @ February 21, 2012 Bond performance Pa r Eq uiv a lent Sp rea d To ta l R eturn B o nd s C urr Avg Min Ma x Z- S 1D 1W 1M YTD Bond Performance - Par-equivalent Spread PD13 746 1047 746 1032 -2.2 0.8% 1.0% 2.8% 5.4% Curr Avg Min Max 1,700 PD14 921 1194 921 1462 -1.6 1.3% 1.8% 6.1% 12.1% 1,600 PD15 1000 1296 1000 1537 -1.7 1.5% 2.6% 9.2% 14.7% 1,500 PD16 1037 1346 1037 1548 -2.1 3.1% 3.2% 12.0% 17.2% 1,400 1,300 PD17 1027 1343 1027 1582 -2.2 2.9% 3.1% 12.0% 18.7% 1,200 PD17N 1089 1388 1089 1607 -2.1 2.9% 3.4% 10.7% 15.7% 1,100 PD21 1140 1461 1140 1594 -2.1 3.3% 4.6% 12.5% 23.0% 1,000 PD22 1140 1377 1140 1584 -2.0 2.9% 3.5% 10.8% 15.5% 900 800 PD27 1056 1312 1056 1500 -2.1 3.2% 2.8% 11.2% 16.5% 700 PD37 1046 1300 1046 1537 -1.9 2.6% 2.7% 9.3% 15.2% PD17N PD13 PD14 PD15 PD16 PD17 PD21 PD22 PD27 PD37 VE13 699 820 698 934 -1.3 0.3% 0.2% 2.3% 4.1% VE13 VE14 VE16 VE18… VE18… VE19 VE20 VE22 VE23 VE24 VE25 VE26 VE27 VE28 VE31 VE34 VE38 VE14 750 936 750 1058 -1.7 0.8% 0.9% 5.0% 8.0% VE16 834 1058 834 1195 -2.3 1.1% 1.5% 8.7% 12.1% VE18 (13.625 1030 1148 1030 1235 -2.0 0.8% 1.3% 5.2% 9.0% Bond Performance - Total return VE18 (7%) 976 1162 976 1332 -1.6 1.2% 1.7% 8.3% 12.7% 14% 1W 1M VE19 998 1178 998 1353 -1.7 1.2% 1.7% 8.3% 12.2% 12% VE20 998 1197 998 1367 -2.0 1.1% 2.0% 9.1% 15.0% 10% VE22 1034 1211 1034 1353 -1.8 1.0% 1.6% 8.9% 13.0% 8% VE23 1028 1233 1028 1409 -1.9 0.9% 0.8% 10.2% 15.5% 6% VE24 994 1234 994 1436 -2.1 1.8% 2.1% 11.7% 17.9% 4% VE25 999 1234 999 1431 -2.1 2.1% 2.6% 11.6% 17.6% VE26 1037 1217 1037 1409 -1.6 1.6% 2.1% 9.4% 14.5% 2% VE27 939 1151 939 1321 -1.7 2.2% 2.8% 12.0% 16.8% 0% VE28 1016 1231 1016 1430 -1.9 2.2% 2.1% 9.6% 16.2% PD13 PD14 PD15 PD16 PD17 PD21 PD22 PD27 PD37 VE13 VE14 VE16 VE18… VE18… VE19 VE20 VE22 VE23 VE24 VE25 VE26 VE27 VE28 VE31 VE34 VE38 PD17N VE31 1043 1237 1043 1413 -1.7 2.4% 2.6% 10.6% 15.4% VE34 1004 1206 1004 1397 -1.9 1.6% 1.8% 9.5% 16.1% VE38 944 1166 944 1384 -2.2 2.6% 2.0% 9.1% 16.2% Notes: for spread performance, the bond (for PDVSA and Venezuela, separately) with the highest z-score is highlighted. for return performance, the past week top and bottom performers are highlighted CDS/Bond Basis B o nd s CDS Pa c ka g e A na ly tic s Term structure of par-equivalent basis PDVSA Na m e Teno r No t l Px D e f Exp 3M B E C urr Lo Hi Mea n Z- S 0 Venezuela PD13 2Y 0.9 103.2 10.5 22.0 -35 -135 305 76 -1.2 PD14 3Y 0.9 95.2 3.9 19.4 -116 -449 65 -137 0.2 PD15 5Y 0.8 94.8 9.6 26.1 -91 -633 30 -167 0.7 PD13 PD16 5Y 0.9 91.4 -1.0 8.0 -128 -707 76 -173 0.4 VE16 -50 PD17 5Y 1.0 91.1 -4.7 7.5 -118 -700 28 -167 0.4 PD17N 5Y 1.0 102.9 5.2 19.2 -180 -768 -43 -227 0.5 VE14 PD21 10Y 0.9 97.3 7.7 20.3 -252 -530 -252 -416 1.8 PD15 PD22 10Y 1.0 118.7 15.4 28.4 -252 -394 0 -213 -0.3 -100 PD27 10Y 0.7 72.0 -2.6 -3.3 -168 -349 209 -111 -0.4 PD17 PD14 PD37 10Y 0.6 68.0 -0.8 -7.8 -158 -343 250 -121 -0.3 VE13 PD16 VE13 2Y 0.9 105.5 19.7 61.7 -119 -138 147 -8 -1.7 VE14 3Y 1.0 104.8 10.0 35.1 -70 -159 114 -31 -0.6 -150 VE16 5Y 0.9 97.6 8.2 26.8 -55 -194 22 -80 0.4 PD27 PD37 VE18 (13.625 5Y 1.3 120.7 -3.1 20.9 -251 -279 42 -118 -1.6 VE18 (7%) 5Y 1.1 91.9 -13.0 9.4 -197 -316 -37 -163 -0.4 PD17N VE27 VE38 VE19 10Y 0.8 93.0 10.8 30.2 -239 -385 -102 -228 -0.1 VE18 (7%) -200 VE20 10Y 0.7 81.4 3.1 20.8 -239 -387 -83 -222 -0.2 VE22 10Y 1.0 116.7 15.2 30.0 -275 -388 -138 -258 -0.2 VE24 VE23 10Y 0.9 94.7 5.5 19.0 -269 -424 -125 -268 0.0 VE20 VE19 VE24 10Y 0.9 90.9 2.2 13.6 -235 -443 -104 -267 0.4 PD22 -250 VE25 VE18 (13.625%) PD21 VE25 10Y 0.8 86.1 0.8 11.6 -240 -450 -97 -262 0.2 VE34 VE28 VE26 10Y 1.1 110.8 7.1 18.9 -278 -470 -278 -362 1.9 VE23 VE31 VE26 VE27 10Y 1.1 100.2 0.4 10.0 -180 -369 15 -156 -0.2 VE22 VE28 10Y 0.9 94.4 1.9 11.4 -257 -437 -113 -262 0.1 -300 VE31 10Y 1.1 110.8 4.3 14.7 -284 -422 -184 -336 0.8 0 5 10 15 20 25 30 VE34 10Y 0.9 94.5 0.0 8.2 -245 -414 -84 -234 -0.1 Average Life VE38 10Y 0.8 79.2 -2.6 0.9 -185 -374 -50 -201 0.2 CDS Notl: notional of the specified CDS tenor based on par-equivalent spread dv01-neutral notional ratio Package Analytics: Px: bond clean price + CDS UF Def Exp: bond dirty price - recovery - CDS notional * (100 - recovery - CDS UF) 3M BE: the amount of basis move (to the left) that can offset 3M carry and roll down of the position Valuation metric: CDS spread - bond par-eq spread. The range (Hi and Lo) and statistics (mean and z-score) are based on past 1Y data. Source for all charts and tables: DB Global Markets Research Hongtao Jiang, New York, +1 (212) 250 2524 Pablo Contreras, Chile, +56-32-299 6195 Venezuelan Relative Value MonitorSource: Deutsche BankDeutsche Bank Securities Inc. Page 5
  6. 6. 22 February 2012 EM Trade Idea Appendix 1Important DisclosuresAdditional information available upon requestFor disclosures pertaining to recommendations or estimates made on a security mentioned in this report, please seethe most recently published company report or visit our global disclosure look-up page on our website athttp://gm.db.com/ger/disclosure/DisclosureDirectory.eqsr.Analyst CertificationThe views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s). In addition, theundersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view inthis report. Hongtao JiangPage 6 Deutsche Bank Securities Inc.
  7. 7. 22 February 2012 EM Trade IdeaRegulatory Disclosures1. Important Additional Conflict DisclosuresAside from within this report, important conflict disclosures can also be found at https://gm.db.com/equities under the"Disclosures Lookup" and "Legal" tabs. Investors are strongly encouraged to review this information before investing.2. Short-Term Trade IdeasDeutsche Bank equity research analysts sometimes have shorter-term trade ideas (known as SOLAR ideas) that are consistentor inconsistent with Deutsche Banks existing longer term ratings. These trade ideas can be found at the SOLAR link athttp://gm.db.com.3. Country-Specific DisclosuresAustralia and New Zealand: This research, and any access to it, is intended only for "wholesale clients" within the meaning ofthe Australian Corporations Act and New Zealand Financial Advisors Act respectively.Brazil: The views expressed above accurately reflect personal views of the authors about the subject company(ies) andits(their) securities, including in relation to Deutsche Bank. The compensation of the equity research analyst(s) is indirectlyaffected by revenues deriving from the business and financial transactions of Deutsche Bank.EU countries: Disclosures relating to our obligations under MiFiD can be found athttp://www.globalmarkets.db.com/riskdisclosures.Japan: Disclosures under the Financial Instruments and Exchange Law: Company name - Deutsche Securities Inc. Registrationnumber - Registered as a financial instruments dealer by the Head of the Kanto Local Finance Bureau (Kinsho) No. 117.Member of associations: JSDA, Type II Financial Instruments Firms Association, The Financial Futures Association of Japan,Japan Securities Investment Advisers Association. This report is not meant to solicit the purchase of specific financialinstruments or related services. We may charge commissions and fees for certain categories of investment advice, productsand services. Recommended investment strategies, products and services carry the risk of losses to principal and otherlosses as a result of changes in market and/or economic trends, and/or fluctuations in market value. Before deciding on thepurchase of financial products and/or services, customers should carefully read the relevant disclosures, prospectuses andother documentation. "Moodys", "Standard & Poors", and "Fitch" mentioned in this report are not registered credit ratingagencies in Japan unless “Japan” or "Nippon" is specifically designated in the name of the entity.Malaysia: Deutsche Bank AG and/or its affiliate(s) may maintain positions in the securities referred to herein and may fromtime to time offer those securities for purchase or may have an interest to purchase such securities. Deutsche Bank mayengage in transactions in a manner inconsistent with the views discussed herein.Russia: This information, interpretation and opinions submitted herein are not in the context of, and do not constitute, anyappraisal or evaluation activity requiring a license in the Russian Federation.Risks to Fixed Income PositionsMacroeconomic fluctuations often account for most of the risks associated with exposures to instruments that promise to payfixed or variable interest rates. For an investor that is long fixed rate instruments (thus receiving these cash flows), increases ininterest rates naturally lift the discount factors applied to the expected cash flows and thus cause a loss. The longer thematurity of a certain cash flow and the higher the move in the discount factor, the higher will be the loss. Upside surprises ininflation, fiscal funding needs, and FX depreciation rates are among the most common adverse macroeconomic shocks toreceivers. But counterparty exposure, issuer creditworthiness, client segmentation, regulation (including changes in assetsholding limits for different types of investors), changes in tax policies, currency convertibility (which may constrain currencyconversion, repatriation of profits and/or the liquidation of positions), and settlement issues related to local clearing houses arealso important risk factors to be considered. The sensitivity of fixed income instruments to macroeconomic shocks may bemitigated by indexing the contracted cash flows to inflation, to FX depreciation, or to specified interest rates – these arecommon in emerging markets. It is important to note that the index fixings may -- by construction -- lag or mis-measure theactual move in the underlying variables they are intended to track. The choice of the proper fixing (or metric) is particularlyimportant in swaps markets, where floating coupon rates (i.e., coupons indexed to a typically short-dated interest ratereference index) are exchanged for fixed coupons. It is also important to acknowledge that funding in a currency that differsfrom the currency in which the coupons to be received are denominated carries FX risk. Naturally, options on swaps(swaptions) also bear the risks typical to options in addition to the risks related to rates movements.Deutsche Bank Securities Inc. Page 7
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