Issue 9
Casting Brazil's Golden Rules
Driven by either a spirit of adventure, starvation or greed, a number of Brazil's northeast inhabitants migrated to remote provinces to develop the country's rich garimpos (alluvial deposits). The discovery of “Serra Pelada", the world's largest garimpo, raised the excitement level and, by the beginning of the early 1980s, these official miners, or garimpeiros, were accounting for up to 91% of total Brazilian gold production.
There is a long history of mining in Brazil - in fact, the Mineracao Morro Velho mine, opened in 1834, is the oldest underground mine in the Western world. But it was difficult for the formal, established companies to compete with the garimpeiros. These companies had been granted some government incentives for preliminary exploitation projects, but they were faced with a number of restrictions imposed by the country's related legislation: a heavy tax burden, difficulties in importing basic equipment, restriction to ownership interest by overseas capital and, most of all, no clear means of selling primary and refined gold.
The high inflation rates of this era led to strong demand from people seeking to buy gold as a hedge, but they had to conduct business within a disorderly and fragmented market. Much was lacking: there was no gold standard to assure the buyer of quality, refining was essentially a fragmented cottage industry of small-sized foundries, and most jewellery transactions were conducted on the black market to avoid high taxes. Although the government recognised that the rich deposits of gold lying in Brazil's growing could provide at least a partial solution to some of its difficulties (a growing foreign debt, high-interest rates and uncontrolled inflation), it did not initially focus on improving the market. With international standards largely ignored, and no well-defined national standards for grade, weight and form, the OTC market lacked both respectability and credibility - although in many cases, it was the sole option available to the investor. There were no appropriate places where gold could be sold or held in custody. Transportation of gold was very precarious and insurance (when it was possible to get insurance) very expensive. Th ere were a number of individual gold-mining state that, propelled by regional greed, levied a variety of taxes on gold.
Order from chaos: the first steps
The first step towards producing a regulated market was taken when the Bolsa de Mercadorias e Funtros (the Futures and Commodities Exchange, BM&F) was set up in Sao Paulo in 1985. The Exchange's first gold trading session was held in January 1986.
Soon afterwards (October 1986), a group of seven companies, comprising mining companies, foundries, transportation companies and financial institutions, fow1dedthe Associacao Nacional do Ouro (ANORO, the National Gold Association). Their ultimate objective was to provide effective conditions for all gold transactions, from production to sales. While it may have been preferable for the government to take the initiative, the political environment of the time favoured such 'market altruism'. The combined ANORO members were in a good position to make government authorities aware of the market's commercial needs and, in particular, to lobby against the high taxes being levied. The concept was to work out some form of partnership with the government with the goal of legitimising and promoting the gold market in Brazil.
The first step ANORO took was to establish a standard for Brazilian OTC gold, similar to international standards in use in London, Hong Kong, Chicago, New York and on the Brazilian BM&F. Members developed_ a Certification Manual, still in use today by the Audit and Ethics Committees when certifying new companies. ANORO verifies the applicant's reputation and standing, inspects a gold producer's plant facilities to analyse how the gold is processed and, ultimately, grants the end product (a 250-gram bar of gold of minimum 99.9% purity), the "Crede ciamento da ANORO" (the ANORO Certification) or the "Padrao Ouro - Brasil" (the Gold Standard - Brazil). Companies now need to have passed the Certification before their gold can be traded on the BM&F.
Partnerships between ANORO and the BM&F, the Central Bank of Brazil and other government entities have resulted in numerous improvements to the market. These include Law Nr. 7.766, which prohibits multiple taxations on gold, as well as a formula to calculate real profits over gold loans (Law 8.383) and exemption of purchases of primary gold from the IPMFTax (the Provisional Tax on Financial Operations). These achievements have allowed the entry of over $1 billion a year into the Brazilian economy. Estimates are that, by 1989, 65% of the gold transactions were legal and annual turnover came to approximately $3l.5 billion.
These partnerships remain in force and they have proved vital in opening up Brazil's gold market to the rest of the world. This was initially done by setting up the arbitrage between gold and the floating dollar and, finally, direct arbitrage (as provided for by CVM Resolutions Nr. 2.012 and Nr. 2.350, respectively).
In 1996, ANORO was both individually and collectively involved in winning the exclusion of "national capital" from Article 176 of the 1988 Constitution. This article had stated that gold mining should be carried out by Brazilian enterprises using national capital, thereby restricting foreign investn1ents to a maximum of 49% of the enterprise. The withdrawal of this restriction has now allowed for strong growth in overseas mining investments.
Sixty tonnes: from where...?
Nowadays, the composition of the Brazilian gold market is, easily defined. On the supply side, the output of mining companies reaches approximately 40 tonnes. As most of this gold is directly exported as a commodity, it is subject to only minimal taxes, due to government incentives designed to stabilise the Country's trade balance. Gold mining companies are further motivated to raise funds overseas through the use of ACCs and ACEs (advance for export contacts), which provide funds at lower-than-domestic interest rates. They can also use hedge mechanisms, such as swaps, futures and options in the domestic and overseas markets.
Garimpo mining's contribution to supply has dwindled, as solid gold becomes less abundant and mining costs rise. Most of the 20 tonnes it currently accounts for are acquired by domestic dealers authorised to make purchases directly from the goldfields. This gold is then considered a financial asset and is taxed at 3.65%. After being processed by a certified foundry, it can be loaded on either Brazilian or overseas exchanges by individual investors and businesses.
...To where?
On the demand side, it has been verified that between exports and arbitrated sales to foreign banks, the overseas market absorbs approximately 60 tonnes of gold.
Turning to domestic demand, the electroplating industry uses approximately 500 kgs/ year for such purposes as printed circuit boards, connectors, bathroom fittings, spectacle frames, clocks and watches, costume jewellery, ornaments, buttons and buckles. Gold is used in electronics to fabricate chips and other electrical products, and by the dental market to manufacture gold-based alloys. These industries together absorb 1.5 tonnes/year.
The jewellery industry accounts for approximately 35 tonnes of gold a year, including the illegal side which, due to the continued heavy tax burden, is still flourishing. Taxes on jewellery account for approximately 51% of the end price.
Market opinion holds that the gap between supply and demand that therefore exists is narrowed through dishoarding by mining companies, recycling of gold and a combination of legal and illegal imports.
It is important to point out that, although the domestic market has shrunk clue to the attractiveness of exporting, the Brazilian exchanges, through their member firms, still offer the public a wide variety of trading options: an active spot market, the BM&F's Teleomo electronic system, an options market and a US-denominated gold futures market.
Now where?
Looking towards the future, the Board of Director s of ANORO has turned its attention to opening up new markets for the gold foundry industry via the draw-back system. This system provides a permit to import precious metals (especially gold) with a commitment to export them after manufacturing as goods with aggregated worth.
It is essential for us to encourage gold consumption in Brazil, especially in the form of jewellery. With taxes as they are at present, Brazil's jewellery industry cannot compete on equal terms with gold entering the country illegally. It is almost certain that lower taxes would immediately result in fewer market restrictions and more transparency in transactions. More jobs would be created, leading to an ease in overall taxes collected by the government. The subsequent rise in domestic consumption would enable our industry to be better equipped to compete in overseas markets.