On Tuesday morning July 9, the first shipment of copper concentrates from the rich site at Oyu Tolgoi (OT) in southern Mongolia left for China fifty miles to the south. It was an exciting day and perhaps an inflection point for Turquoise Hill Resources (TRQ) which owns OT 66-34% with the GOM (Government of Mongolia). One must mention politics and the government up front in discussing these matters for resource nationalism has been a large part of OT's development for years. Mining giant Rio Tinto (RIO) bought a majority interest in OT from Robert Friedland and Ivanhoe Mines in January 2012, upped its holdings in July 2012 and changed management. RIO controls OT through its 51% share in TRQ.
OT is expected to produce 330k tons of Cu (copper) / year and 495k oz. gold. When Phase I development is complete it will become one of the world's top-five copper sites, vying with the Escondida mine in Chile and Freeport McMoRan's (FCX) Grasberg District in Indonesia.
A recent instance of the project's sensitivity to Mongolian politics was the June 20 request from the government of President Elbegdorj Tsakhia that ore concentrate not be shipped while the Presidential campaign entered its last week. There also had been demands that RIO deposit funds from exports inside Mongolia. RIO has rejected the latter demand but agreed to delay shipping the concentrate. An understanding may have been reached with the President about exports and freedom in depositing proceeds if he was returned to office. On June 26 he won a narrow (50.2%) majority of the vote in a three-way election and has begun his second term. His Democratic Party also controls the legislature and the Prime Minister is a member. This should facilitate clarity in policies including those on foreign investment and exports.
Events at the end of 2012 and early 2013 indicate how things have gone previously for RIO and TRQ regarding OT. Last December 27, at a joint government - Company press conference, officials from the Mongolian Mineral Resources Authority and the President lauded RIO and TRQ's commitment to creating value for Mongolia and maintaining the traditions and land. Five weeks later, January 31, TRQ produced the first ore concentrate at OT. Within a week, President Tsakhia was in the news demanding a greater share of revenues, expedited development and Mongolians on the board of RIO. Everything slowed down and TRQ sagged from a high above $10/share early in January. At the end of February, Mongolia suspended the licenses of Entrée Gold (EGI), a Canadian junior that has the rights to explore and develop the Hugo North mineral vein at OT. EGI said negotiations were proceeding and hopes to be producing gold from its property by 2019. Streaming company Sandstorm Gold (SAND), RIO and TRQ own 12%, 11% and 9% of EGI respectively. EGI also has copper and molybdenum properties in Nevada. Its Chairman of the Board is Lord Howard, former head of Britain's Conservative Party. At .38/share it, like TRQ and RIO is near the bottom of its 52-week trading range.
While the shipping of copper concentrate boosts prospects for TRQ and RIO which wishes to diversify away from its primary product, iron ore, there is no simple relation between share price and operational progress. TRQ rose the week of July 1 from about $5.20 to $6/share after Elbegdorj was reelected and the shipment approached and then occurred. A day later, July 10 TRQ sold down 3.52% to close at $5.75. Initial excitement may already have subsided ("buy the story, sell the news") and experienced observers know that the possibility of 11th and 12th hour surprises from the GOM can occur. It will take a couple of years of steady operation and political stability until potential and current TRQ investors can stop looking over their shoulders, waiting for the other shoe to drop and selling while still in profit. TRQ investors must assess their personal situation and see how much volatility they can tolerate and the level at which they would withdraw. Buy TRQ at the next downdraft but be mindful that global growth is slowing and the monetary system is loaded with snags.
RIO's prospects with OT exporting certainly improve. If operation and development at OT continue, and the EBRD and US Ex-Import Bank loans will help, its output now is diversified. Its copper output will grow to $9 billion/year, from a fourth to more than a third its $24.5 billion iron revenues, and it is becoming a significant producer of gold. Remember, RIO also has a 40% interest in FCX's enormous copper and gold mines at Grasberg. But in judging RIO's outlook one must consider two different scenarios for global economies in the next few years.
The sunny scenario requires that the major economies formulate a coherent reserve system and fiscal policies not based on debt creation, currency wars and leveraged derivatives. They will need to reduce taxes and the power of governments to stifle and distort business and markets via regulation. They would need to strike a balance between development and environmentalism based on science not hysteria or selective political agendas that target certain Western corporations while leaving Asian nations and companies to pollute at unprecedented and unmanaged levels. Discouragement of procreation will need to relax even to mitigate much less avoid demographic collapse that by itself is taking down economies and nations in tandem with unsustainable credit expansion.
If changes in these areas begin, organic demographic-economic development and growth based on coherent fiscal policies will encourage and reward the productive capacity of producers and suppliers of basic goods like the major mixed commodity miners, RIO, BHP Billiton (BHP), FCX and Vale (VALE). Energy companies like Exxon (XOM), Chevron (CVX) and Shell (RDS.B) also will thrive. So will Halliburton (HAL), Caterpillar (CAT) and Nucor (NUE) as will other companies in mixed industrials, basic materials and commodities. Except for the oil and gas giants, most have had great pain the past two years with the mixed commodity miners suffering most. VALE has been worst of all (-30% YTD) as it steadily has lost market share for six years to BHP and RIO as the latter two companies increased production even in the face of falling prices. If aspects of the "sunny scenario" occur, the long-lagging miners will thrive.
However, it would require a revolution in cultural dynamics and perhaps in human nature for the gigantic financial-diplomatic-social managing systems that modern states have become to diminish themselves. Tradition says that the Creator did this to enable creation, in all its myriad and marvelous particulars to proceed. But we are considering the State, what Nietzsche termed, "the New Idol." The interlocked major economies do not so much cooperate to maximize the world's miraculous wealth and productive promise as they facilitate and manage crises. One could write a trilogy on this process covering just the past century. They prefer to expand their power.
Thus, though one hopes for sun, the darker scenario is more likely. Currency wars and debt creation continue to cripple organic economic recovery and bring volatility to all asset classes. Demographic collapse engulfs Japan, disorders and hamstrings Europe and America as increasing immigration, legal and illegal creates or exacerbates socio-economic problems. Real net worth, income and spending slow and shrinking demand initiates deflationary pressures. Basic material producers like the miners create more but make less: eventually they produce less, too.
However, in the darker and at this juncture more plausible path, it is precisely the major producers and suppliers who will survive, albeit at impaired capacity. In this my view is similar to Jim Rogers and others who believe the secular bull in commodities has years left to run although I believe it may be at lower levels than in its first decade. Companies that survive this era of constraints will be diversified major players. Indeed, a process of consolidation and acquisition could occur. This would accord with 130-year trends in industries as diverse as oil, gas, railroads and media.
RIO is a deep-pockets company with a board whose expertise and collegial affiliations will navigate and help shape the coming decades, a world whose fiscal, monetary and social regimen will be quite different than today's. The same is true of BHP, British Petroleum (BP) and other major producers like those noted above. The mixed commodity miners have been hammered for years, they pay good dividends, are diversified in materials and geography and the best of them, RIO, BHP and FCX are strong value and contrarian buys in my view. Because of their depressed values, essential products and enormous upside they almost are as strong in defensive positioning as Consumer Staples (VDC) or investment companies tied to food and energy like Sprott Resources (SCPZF.PK) profiled here. The only more secure sectors to my eyes are Health Care (VHT) and, for wealth preservation, short term corporate bonds (VCSH). Health Care, however is at the top of its range and while it will do well in either the sunny or shadowed paths the value buys are in the better mixed commodity miners including precious metal miners like Goldcorp (GG). In the mid-tier space, consider First Majestic Silver (AG) whose output in silver, gold, lead and zinc and revenues are surging, has little debt and keeps a careful rein on costs, and Eldorado Gold (EGO), a low debt, dividend paying mid-tier with fine properties. I discussed them here and here.
While some prefer BHP or FCX which, with its recent acquisitions is now a balanced mixed mining and energy behemoth with great upside, I believe RIO too is a sound investment now and going forward. It closed July 10 at $40.54 and has a 12-month consensus target of $70 (75% above its current price) with a preponderance of strong buy ratings. For those with patience and aware of its history of political surprises it is good to enter TRQ at about $5.50.share. But note that the rest of this year and probably 2014 will be stormy as monetary and debt issues shake bond and housing sectors and thus markets and entire economies.