Turquoise Hill And Rio Tinto: Are They Good For Mongolia?

| About: Rio Tinto (RIO)
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The short answer is yes, definitely. Rio Tinto (NYSE:RIO) and its subsidiary companies are the most productive, charitable and environmentally protective influence ever to arrive in that harsh land. But there is another legitimate answer, "it depends" and another pertinent question: "is Mongolia good for RIO and Turquoise Hill (NYSE:TRQ)?" That answer and query will be considered after discussing the reasons that RIO and TRQ are very good for Mongolia if it wishes to join the modern world, its wealth and commerce, which is a challenging proposition.

The development of vast mineral resources in Mongolia has been and continues to be plagued by Mongolian politics, global organizations and major powers both before and behind the curtain. The main obstacle in the near future is elections for President and Parliament. Originally scheduled for May, they now are tentatively set for late June. But often in the Far East one must be aware of 11th and 12th hour surprises. This article offers perspective on Mongolia for current, past and future investors for the vast potential and varied pitfalls of TRQ have shaken off many shareholders as its saga proceeds. Three of my previous pieces on this tale may be read here, here and here. Jon Springer also has an informative blog on Mongolia.

Rio Tinto is the parent company funding and hoping to profit from development of the mines of Oyu Tolgoi (copper, gold, silver, cobalt and more) and Ovoot Tolgoi (mainly coal). It owns a controlling 51% in TRQ and through it owns 58% of coal miner South Gobi Resources (OTC:SGQRF) whose top management it changed last fall. The north side of Oyu Tolgoi has a rich vein of gold being explored by Entrée Gold (NYSEMKT:EGI) which is about 24% owned by Rio directly and through TRQ. On February 15 EGI contracted with junior gold-streaming company Sandstorm Gold (NYSEMKT:SAND) that is providing $55 million for EGI's project in return for a $5 million future royalty and 17.857 million shares. EGI has licenses to land holding about 33% of Oyu Tolgoi's gold and 18% of its copper. This is the cluster of companies under Rio's aegis trying to develop and market the vast mineral resources in a land of 3.18 million people, many of them still living a semi-nomadic life.

Yes, TRQ and RIO are good for Mongolia but that depends on what Mongolia is and wants to be. It is in the United Nations like two hundred other states, most of them former colonies having little claim to cohesion. Except for its 150-year period of imperial pillage Mongolia has not had a state, coinage, literacy or other basics of nationhood. A pastoral people organized by clans and loose tribal affiliation, there is territoriality but little sense of borders. Its religion is borrowed from India via China. Mongolians were dragged into the modern world by Soviet Russia and a Soviet-trained polemicist and journalist, Tsakhia Elbegdorj, now President, more recently buffed by Harvard, has guided it most of its brief period as a nation state. It is a vector of the world's three major power blocs: Oceania, Eurasia and East Asia in Orwell's useful terms or more narrowly, Russia, China and Anglo-America. Rio Tinto is an Anglo-Australian mining company, third largest in the world (market cap about $70 billion).

The IMF affirms Rio's policy that the government of Mongolia will receive about 71% of the proceeds of the mine whose current value is rated above $1.3 trillion. They may be pricing it in another currency in a few years but you see the point: the project is vast.

TRQ processed the first ore concentrate on January 31 but phase 2 production set for June 2013 has been pushed back 3 years pending outcome of Mongolian elections now scheduled for June. Political uncertainty and Mongolian government demands have led Rio to trim investment by 35%. The target price on TRQ recently was cut from $13.75 to $10/share. Since mid-January TRQ's share price has made a descending series of 52-week lows, touching $5.86 in miner panic week (April 1 - 5) and rests at $6.16 as of this writing.

The Mongolian government, like most others, buys popularity and credence by borrowing money for "social welfare" programs. It operates by debt and this makes its politicians eager to grab money wherever they see it while decrying corruption. Politicians both in and out of power complain that RIO declines to renegotiate its royalty agreement and give them more money. They disguise their demands in terms likely to produce support from the UN and NGOs, concerns for the environment or "equal pay for equal work" though Mongolia is not known to have many PhDs in metallurgy, geology, chemistry, industrial engineering, management, etc. Mongolians abroad and at home need to learn Spengler's dictum that "through money, democracy becomes its own destroyer."

The deal is that Mongolia does not get its handsome royalty payments until RIO realizes the $6.5 billion it has sunk into Oyu Tolgoi so far. But Mongolian politicians want the money now. President Elbegdorj wants Mongolia to get a bigger royalty and more control of the project. It has become a refrain, a regular part of his stump speech. "It's time for Mongolia to have Mongolian representation on the management team," Elbegdorj said February 1. "It's important that the government takes the Oyu Tolgoi matter into its own hands." This is foolish posturing.

RIO need not proceed if it cannot get 30% or more back on an immense investment into what had been a huge patch of land that for millennia produced nothing but storms of yellow dust and occasional hordes of deadly marauders pillaging from Japan to central Europe, from Siberia to India, Persia and the Promised Land.

Mongolia's alternatives to development of the sites by RIO, TRQ and South Gobi are Russian or Chinese companies. As to the former, Mongolia had seventy years under the Soviet Empire and got some concrete high rises, a few paved streets and a rudimentary sewer system. As to the China option they need only look south to the Heavenly Kingdom's province of Inner Mongolia which Chinese methods have turned into a toxic wasteland resembling Mordor in Lord of the Rings. They also might consider how the Chinese have dealt with the Tibetans. I have written before about RIO-TRQ's western sensitivity to the land, livestock and traditional folkways. This often overdone idealization of the primitive will serve and has served Mongolians well. Under Anglo-Australian development they will be able to continue their pastoral ways if they choose and if they can resist the allure of modern technology and pop culture.

The toxins have begun: Mongolia has a rapper, "Gee," and here is his contribution to the debate: "People who have power, they will get the wealth, and they will get more powerful. People like us will not get it." Clearly he has drunk deeply of "the liberal mind-set," a Mongolian populist ready for Hollywood and its chic resentment. Perhaps he could consult to Danilo Medina, President of the Dominican Republic, last heard jerking the chain of Barrick Gold (NYSE:ABX) for a bigger slice of the Pueblo Viejo project into which Barrick and Gold Corp (NYSE:GG) have poured $4 billion after spending $5 million to clean up a pre-existing mine site.

But in Mongolia everything waits on politics. As of now, the elections remain unsettled as to date and who, if anyone, will oppose President Elbegdorj. Also see this March 26 update on the election from the "Office for Democratic Institutions and Human Rights" located in that bastion of civil rights, Warsaw.

That brings us to the other answer to the question of whether modern mining technology and wealth in the form of RIO is good for Mongolia. As above, the simple answer is yes: a more nuanced answer is it depends on whether Mongolians ever figure out if it is better to be a pastoral people ruled and mistreated by Russia or China or hooked more elegantly into the matrices of the digital world, screen-spectacles, consumerism, urbanization and sedentary Western ways. One readily could make the case that a pastoral lifestyle is infinitely richer, more sensuous, human, perceptively acute and in some ways healthy than being connected and enslaved to a grid, manipulated and degraded by politicians, political methods and public school conditioning that softens mind and spirit. Theoretically one could balance the two worlds: I hope Mongolians can for they will have the Russians, the Chinese or the Anglo-American bloc developing their mineral wealth and making their barren land bloom. They should count their lucky stars that Robert Friedland arrived with Ivanhoe Mining and that in April 2012 RIO bought him out and continued the work.

Lastly, are Mongolia and its grasping, big-power tutored politicians, tools of NGOs (non-governmental organizations) good for Rio Tinto and TRQ? The answer for RIO is yes but it will need plenty of Alka Seltzer and patience and plenty of guarantees: maybe hostages would help (that's a joke). Its relations with lenders seem good based on a recent $3 billion loan pledge from the EBRD (European Bank for Reconstruction and Development) and a host of Australian, European and Japanese Banks. They know RIO can repay the amount with a few months of the project's production: in fact, RIO could repay even if it decides to shut it down. An essential component of the financing is that it is "insured against political risks by the World Bank's Multilateral Investment Guarantee Agency."

Such insurance is essential as the experience of Vancouver-based Entrée Gold shows. On February 25, a wire report came that their license to develop had been cancelled by Mongolia's Mineral Resources Authority. The next day EGI issued a press release denying a cancellation and saying that "Entrée is in discussion with the Government, RIO and TRQ on this matter." On March 28, EGI's fiscal 2012 report noted "continuing negotiations." CEO Greg Crowe mentioned the "negative effects" on production relating to Mongolia's upcoming election and, of note to investors generally, "global economic contraction." On shrinking growth worldwide see my previous piece examining the thesis for Precious Metals, II. The information on major global mining, construction and agricultural companies is vital to all investors.

Every time I read about Mongolia I'm reminded of a brief exchange I had with an Indian-American software engineer who travels the world on business. Regarding his experience in East Asia he said, "There's always a problem and it's never their fault." That fits the situation in Mongolia. So, is Mongolia good for RIO, TRQ, SGQRF.PK, EGI and their shareholders? Yes, if RIO remains very firm with the locals, if the locals get smart about their interests, politicians and neighbors and especially because RIO is "insured against political risks by the World Bank's Multilateral Investment Guaranty Agency." Thus they are more soundly capitalized than the US Treasury.

Takeaway: Even more than other miners, TRQ, SGQRF and EGI will be volatile and thus better for trading than long term holdings, at least until production is underway a year or more. There are many good mining plays for which readers may consult my previous articles on this sector.

Constant uncertainty typifies RIO's experience in Mongolia whose people don't realize that their politicians are killing a goose that will lay golden and copper eggs for them. Good luck, RIO, good thing you got that insurance for political risks. Mongolians, wake up! RIO will add wealth and best protect the primal beauty of your land. Be moderate in your embrace of the modern world and be skeptical about politicians.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in EGI over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.