Ecuador Miners Subject to Political Risk - With Risk Comes Reward

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 |  Includes: ETQ, IAG
by: Mark Turner

Just when things seemed to have turned around for a whole batch of junior miners in Ecuador, political risk once again rears its ugly head. Along with juniors operating all over the world, mining companies with heavy Ecuador exposure such as Aurelian [ARU.to], Corriente Resources (ETQ) [CTQ.to], Lateegra [LRG.v] and IAM Gold (NYSE:IAG) amongst many others had begun to rebound from the sector-wide subprime hammering. All seemed set fair for a healthy rebound until Reuters dropped this little bombshell yesterday afternoon:

QUITO, Aug 22 (Reuters) - Ecuador's President Rafael Correa wants an upcoming special assembly on rewriting the constitution to forbid open pit mining and to prevent drilling in biologically rich areas, said the government's top candidate for the body.

Alberto Acosta, Correa's pick to lead the campaign to win a majority in the Sept. 30 vote for assembly seats, said reforms are needed to protect the country's ecology from the nascent mining industry.

"Ideally, I would prefer to stop all large-scale mining," Acosta, a former energy and mines minister who quit to run for the assembly, told Reuters. "But at least by stopping open pit mining, we can protect our natural wealth."

The story continues, but we doubt many fund managers got past the third line before hitting the ‘sell’ button. The result? Well, here’s the Aurelian 5 day chart:

ca aru

And here’s the Corriente 5 day chart:

etq

There are plenty of other examples that are depressingly similar.

As we currently have a “buy” rating on Aurelian, it was a little irritating to see such a report slice yet another tranche of value off the stock, coming only 1 day after the release of yet another excellent set of drilling results at their Fruta del Norte [FDN] prospect which immediately (and rightly) pushed the stock higher. In a previous article we went into more detail about this most exciting of gold prospects, but suffice to say that the latest infill drill results confirmed and even added to expectations at FDN. Aurelian will soon publish a 43-101 compliant resource estimate, at which point the truly enormous amount of gold contained at the site will begin (and only begin!) to be recognized by a wider public.

But back to the present issue. After the news came out yesterday afternoon I spoke with Alonso Soto, the Reuters reporter who broke the story. Before continuing, I’d like to point out that this is not the first time I have spoken to Alonso Soto. We have had several phone conversations in the last few months about the developing story in the Ecuador mining and energy sectors, as well as more general discussions on the political scene in the country. I have always found him open and honest, and although we have never met face to face we have a friendly telephone relationship. I believe him to be a good reporter who does his job well. So be it.

In our phone conversation yesterday, Soto gave me a bit more background on the story that hit the wires. When I mentioned to him that most of the damning content was not exactly new (e.g. Alberto Acosta has already voiced his opposition to open-pit mining), he told me that ex-minister Acosta (more about him in a moment) was very keen on mentioning and reiterating his views on mining. The comments came as part of a wide-ranging interview, but Soto said that Acosta spoke primarily, repeatedly and very strongly against the nascent mining industry. It was a story that had to be reported. The bottom line is that Acosta wanted a story to hit the wires, and if it hadn’t come out yesterday it wouldn’t have been long in coming anyway. Don’t kill the messenger.

So who is Alberto Acosta, and why would the comments of an ex-minister move the markets so quickly? To answer this, we have to leave mining and finances for one moment and take a brief but necessary diversion into Ecuador’s current political scene.

Firstly, this is no ordinary ex-minister. Alberto Acosta is one of President Rafael Correa’s inner circle of trusted advisors and friends. He resigned from his post as minister for mines and energy to head up Correa’s bid to take majority control of an assembly that will re-write Ecuador’s constitution. The assembly is to be decided by national election held 30th September. To cut a long story short, the process is of the utmost importance to the present administration, with Correa going as far as saying he will step down if his party cannot control the new assembly and push through his desired reforms. Outside forces also understand the significance of this election; only yesterday the European Union announced it was sending 100 observers to oversee proceedings and were quoted as saying it is indeed a “crucial moment” for Ecuador. So in fact President Correa has given Acosta what is widely seen as the most important job in the present government (bar the President’s job itself), and Acosta’s influence should not be underestimated by anybody. He is arguably the number two power in the country today.

Acosta’s background is more than interesting. He is widely traveled, is a qualified economist who lived and studied in Germany, and has many years service in Ecuador’s state oil company. Before becoming part of Correa’s inner circle, he headed up a small economics think tank. He is left-leaning and pro-ecology. His wife is a green-issues activist. He has close contacts with influential indigenous communities who regard him as a champion of their cause. He is regarded by both friend and foe as highly intelligent.

With less than six weeks to the assembly vote the outcome is by no means decided. Many political analysts say that it will be difficult for Correa’s party to gain the necessary majority, in part due to the sheer number of candidates (over 3000) vying for the 130 seats available. This now, at last, brings us to the point of this political preamble.

This analyst believes that Acosta is using mining as a political chess piece. In our considered opinion, yesterday’s polemic statements were designed to rally support for the government and their candidates for the new assembly. With the crucial vote close at hand, Acosta wants to shore up votes among the same people that gave Correa his landslide victory earlier this year and also indigenous communities that might otherwise fracture their vote amongst the myriad of candidates available. Acosta needs to win the assembly majority at all costs; playing the nationalist card, environmental card and making foreign mining companies scapegoats may be cheap shots, but they are also strong short-term moves that win votes amongst the rank and file. Acosta is a highly-influential figure and his opinions must be heeded, but right now he’s playing a bigger game than just “whack the miner”. Put simply, whatever he says in the next six weeks won’t close down any mines.

We have stated before the opinion that Ecuador is a mining-friendly country. That view has not changed. Those holding shares of miners with Ecuador exposure may be in for a rough ride in the next 6 weeks or so, but post September 30 we believe that Ecuador will resume its previously stated commitment to developing the mining industry as part of the larger task of developing the country economically. The chances are that Acosta is also pushing for a higher percentage of mining revenues for state coffers, perhaps via royalty payment or higher rates of more traditional taxation, but this alone should not put off the long-term investors that see the same value as we do in companies such as Aurelian and its mighty FDN. Although political risk will probably remain high in the short-term there is no reason to change any recommendations, as we always take a long-term view on stock purchases. What is more, people who buy stocks of any company with LatAm exposure should be prepared for precisely this type of unpredictable political risk. With risk comes reward. Hang in there.

Disclosure: The author has a buy recommendation for clients on Aurelian (ARU.to).