The roller coaster ride continues for shareholders of Turquoise Hill Resources (TRQ). Investors were underwhelmed by production of the first ore concentrate January 30, though it presages steady operation by summer and profit thereafter. This complex situation is described below and investment guidance provided. Read on.
The ore concentrator was inaugurated late in December with fanfare including statements by Mongolia's president and mining director who invoked the legacy of their ancestors and good of the people. Reports on those events sent TRQ's share price up 35% in two weeks before news of Mongolia yet again seeking more royalties (i.e. welfare) gave it nearly all back. On January 30, as prices plunged the exchanges halted trading even as the world's second largest miner, Anglo-Australian Rio Tinto (RIO), denied a Bloomberg report of contract disputes and affirmed that the agreement was solid. Still, shares subsequently sank to $7.66 at the close of trading February 01 while major indices extended the secular triple top and resumed their push toward all-time highs. On Monday Feb. 04 as the markets gave up recent gains, TRQ shares touched $7.40. But Mongolia's a world away from that euphoria and offers buying opportunities for the careful and attentive investor looking to diversity his holdings.
It is possible that some of the parties involved with TRQ wish to depress prices and increase their holdings or leverage by picking low-hanging fruit. To appreciate this high stakes game it is important to consider the cast of characters and murky events surrounding the emergence of nomadic Mongolia into a hi-tech, high-stakes world.
RIO owns a 51% stake in TRQ. TRQ, originally Ivanhoe Mines the creation of mining legend Robert Friedland owns 66% of the world's greatest copper, gold, silver and coal mine at Oyu Tolgoi ("Turquoise Hill") in southern Mongolia. The government of Mongolia (GOM) owns 34% and many of its politicians would like to increase this share. The vast project, the largest construction site in the world, is run by Oyu Tolgoi LLC which says "71% of cash flow generated [by the mine] will be received by the Government of Mongolia in taxes, fees, royalties and dividends." It also states that "Oyu Tolgoi carries out its activities in an open and transparent manner" and extols its elaborate programs for environmental stewardship, employment and education. RIO and TRQ indeed have donated large sums to Mongolian charities and consumer services while the fledgling State's government spends its way ever-deeper into debt. This and intra-Mongolian political and personal rivalries is the context for continuing rumbles about the contract.
Mongolia needs RIO and Turquoise Hill to be profitable, both for their own value and to attract increased foreign investment. The nation has only 2.8 million people and its immense mineral resources require immense investment by RIO to unearth. This will increase if politicians and governments including those of neighboring China and Russia do not mess things up. RIO-TRQ have invested $6.5 billion aside from charitable giving: that's a lot of money. A less enlightened age might expect the major players to brush the Mongolians aside and make the area into a bounteous Eden feeding a world resource boom. But in our "sensitive" era the paths of empire proceed in more complicated ways.
The entire experience may have RIO executives wondering why they didn't choose a relaxing profession like de-activating bombs or working the floor on Wall Street. Friedland, co-chair of Ivanhoe Energy (IVAN), retains 10% ownership of TRQ after having been nudged aside by RIO in April 2012. RIO also has installed its own management at South Gobi Resources (SGQRF.PK) 58% of which is owned by TRQ. This has led to more direct tangles between RIO, Mongolia and China. For example, Chalco, China Aluminum International Trading Co. wanted to buy South Gobi but Mongolia rebuffed them for reasons of economic nationalism. Mongolia also rebuffed offers by American and Chinese companies to develop its 7.5 billion ton coal mine at Tavaan Tolgoi. Now Mongolia wants out of its agreement to sell China coal from the mine. Mongolia's Batsuuri Yaichil says his state is losing money on the deal and GOM wants to sell to other international customers at higher prices. China says it will "seek compensation for breach of contract." And so the game goes on.
Takeaway # 1: It is impossible to do business with or in Mongolia without snafus arising from internal disputes within GOM (current and past participants) and deep ambivalence about foreigners. Mongolia has an "Independent Authority Against Corruption" which helps apply pressure. This includes detaining foreigners working on its own board. This has happened to Justin Kapla, President and CEO of South Gobi Sands a subsidiary of South Gobi Resources and thus part of RIO's extended family of companies in Mongolia. The lesson is that investing in the company must pursue the following path.
Takeaway # 2: Shares of any company in Mongolia are subject to many risks difficult to foresee. So wait for one of the frequent steep corrections arising from takeaway #1 and put a portion of your invest-able cash to work. After substantial gains, cash out and, if you are so inclined, re-enter at the next major problem and ensuing dip which is almost certain to occur.
While the chaotic situation and contradictory reports on Oyu Tolgoi accumulate, Morgan Stanley estimates that this will be the fourth consecutive year in which world copper demand exceeds supply. As water flows downhill, wealth will flow to the deepest pockets and strongest willed of those focused on Oyu Tolgoi. Bet on Britain and the game of endless conflicts. It's all about playing the game. Play with caution as noted above.
"We are on schedule" says RIO's Mongolian spokesman Illtud Harri. Yet per the game, upheaval around the edges continues. Just a couple of weeks previously RIO replaced CEO Tom Albanese for what turned out to be his unfortunate acquisitions of Alcan and Mozambican Coal. RIO recently took a $14 Billion write - down on the deals. This may be positive for long term profitability but it adds to the rough weather around RIO's development of its holdings in Mongolia.
As noted above, Justin Kapla, a young American from Minnesota, a member of the Business Council of Mongolia and an executive for South Gobi Sands has been detained in the country since October. South Gobi Sands LLC is a division of SGQRF and its major coal mine at Ovoot Tolgoi. The travel ban on Kapla is related to the IAAC's ongoing investigation of Mongolia's former Mineral Resources Authority chair who now is in jail. It seems that mining licenses were transferred to friends and large sums moved in improper ways. South Gobi's Attorney Sarah Walsh however was released late in December. The seemingly selective justice is part of larger power plays. The storyline and logic are unclear but the pressure and pain are real. See the splendid articles of Seeking Alpha's Jon Springer for ongoing coverage of this conundrum and many matters pertaining to the turbulent saga of 21st century Mongolia.
Regarding that saga, those thinking of investing in Mongolia should research the history of Bat Khurts, head of Mongolia's National Security Council and Enkbhat Damiran of the General Intelligence Agency of Mongolia (GIAM) and its relations with Europe. There likely is material there for a book on Interpol. It also is worth studying English geopolitics and the role it plays with China and Russia in assembling and managing a collectivized world system. Other essential reading is the report of the US Embassy in Ulaan Bataar on the Business - Investment climate in Mongolia. The Report quotes various laws that permit foreigners to be detained and foreign-owned properties to be seized for loosely defined reasons. Then there is former President Enkhbayar vowing to return from jail and re-negotiate the deals with RIO and other companies. The columnist writes of "collusion at the highest levels of government and the judiciary" and "the corruption of President Elbegdorj's regime." The situation around RIO, TRQ and foreign investment is a volatile mix of cultures, personalities and trans-national agendas surrounding a fabulous property.
Humpty Dumpty famously noted that power defines the meaning of words and laws: "the question is which is to be master, that's all!" The oligarchies that run England, Russia and China are ironing out various disagreements about allocations of resources through the companies named above and some people unfortunate enough to be in the way.
Takeaway # 3: In my first piece on TRQ I wrote that its story is like a postmodern novel being written by several characters with limited interest in closure. The logic in the case, the richness of Oyyu Tolgoi is the center of attraction but peripheral matters determine the status of the core. As a reader wrote, Mongolia needs Oyu Tolgoi, TRQ exists for it, RIO and China need it and Mr. Friedland has much invested in it. But as I also noted, there is a giant gap between reason and reality for evidence of which compare U.S. and European stock markets to their respective nations' economies. For now, if you want to share in Oyu Tolgoi you buy TRQ and keep alert for stormy weather. The mine itself should produce long term and sustainable gains. Just be ready to exit most of your position and re-enter when calm returns. Vigilance is urged. Buy below $7.50 and monitor the situation carefully.
Takeaway # 4, PS: Mongolia is not for all investors. And while that nation continues its highly ambivalent dance with the modern world, we need equal caution about events at home.
My most recent article noted the secular triple top the indices had made by January 25. It was pushed still higher Feb. 01 and media euphoria is growing. Beware: sentiment grows bullish but workforce participation levels are still near depression levels and worsening. Real GDP growth minus devaluation is disturbing; measured against gold, as would have been done until the abrogation of Bretton Woods in 1971, it shows a 70% decline. And GDP is a political metric that includes lots of waste. This market is as over-stimulated, distracting and unhealthy as a Super Bowl halftime show. When the lights go out, there will be more than a half hour game delay. Until next time, look into silver the miracle commodity, play it with Silver Wheaton (SLW) or a bullion ETF (SLV, [PSLV]) and remember: caveat emptor.