One of the world's fastest growing economies could offer significant resource potential...
FEARS investors have about Gold Mining stocks are misplaced, says James Passin, hedge fund manager with New York-based Firebird Management. Especially if those companies are mining in Mongolia.
Firebird manages a portfolio of private equity funds that invest in Mongolia, one of the fastest growing economies with some of the most extensive, untapped resources in the world. The country is already home to the largest copper deposit and in this interview with The Gold Report, Passin explains why there is potential for dozens more similar finds.
The Gold Report: Will China's recent interest rate cut have an impact on the Mongolian economy?
James Passin: It's hard to say. The more important question is: To what extent will China's monetary and credit policy offset the weakening trends in the Chinese economy? The Mongolian economy will be dramatically impacted by Chinese economic conditions.
TGR: What's happening in Mongolia in terms of growth and opportunities?
James Passin: Mongolia is the fastest growing economy in the world. The economy has been compounding at almost 20% in real terms. There's a lot of evidence that the real gross domestic product (GDP) is a lot higher, due to unreported economic activity. The trends underpinning this growth are still intact and the economy is growing from a very low base. It's likely, if not inevitable, that Mongolia's economy will continue to compound at an extraordinarily high real rate of return for the next several decades.
TGR: What other countries would you compare Mongolia's growth trajectory to?
James Passin: Looking back to the beginning of the great oil boom in the Gulf countries, such as Kuwait, there is similar economic potential and a similar population base, too. Those economies grew from very small bases to become substantial and important from a global perspective. This was driven by the export of oil, but also from sustainable policies of building up sovereign wealth funds and maintaining strong sovereign balance sheets.
Mongolia has other attributes that might even lead to more rapid and sustainable growth, which includes its very strong democratic political system, the breadth of literacy, its natural entrepreneurism and its proximity to some of the most dynamic economies in the world, such as China.
Present day, it's very hard to find other countries that have similar potential. The countries that look interesting today—Myanmar, North Korea—have various issues and problems, but also very exciting attributes.
Mongolia is an early-stage frontier market with many of the problems typically associated with developing countries. But, it also has a fairly advanced civil and political infrastructure. Its unique setting will enable Mongolia to continue to compound at extraordinarily high rates of growth—rates of growth that are going to continue to attract both strategic and portfolio investors.
TGR: But if China sneezes, Mongolia gets a cold. If China's growth drops to 7% this year instead of its projected 8%, how much is that felt in Mongolia?
James Passin: There is a very high correlation between Mongolian exports and Chinese demand. There is a very quick pass-through mechanism from China to Mongolia. Even a moderate slowdown in Chinese growth could have a disproportionate effect on Mongolia.
However, the Mongolian banking system is much stronger than it was during the global financial crisis. The sovereign balance sheet is strong relative to the size of the economy. The likelihood of Mongolia having any kind of severe crisis or systemic existential problems is quite low—even if there is a more dramatic deceleration in the Chinese economy.
TGR: Is China one of the bigger contributors of foreign direct investment (FDI) in Mongolia?
James Passin: Absolutely, China is a significant contributor of FDI in Mongolia. From 1990 to 2010, China was responsible for about 50% of its FDI.
FDI from China is quite controversial. In fact, a law was recently approved by parliament that is directed at regulating FDI primarily from China. These days, a lot of the FDI is flowing from Canada, Australia, Japan, South Korea, Europe and the US China is a large contributor to FDI, but it's not the dominant contributor. However, FDI is primarily facilitating the construction infrastructure needed to deliver raw materials to China. So, ultimately, the FDI story is still very much China-driven.
TGR: How would you compare the investment risks in Mongolia with the investment risk in countries like Kazakhstan, Uzbekistan and Turkmenistan?
James Passin: I know Central Asia quite well, having traveled extensively throughout the region over the last 15 years and having deployed capital in various equity plays in Kazakhstan. While we historically generated significant net returns investing in Canadian-listed companies that were de facto vehicles for the Kazakh elite, we do think that Mongolia alone of all Central Asian countries has the potential to develop a deep and globally significant domestic capital market.
One of the key facts to remember is that Mongolia is a democracy. A democracy is arguably inherently more stable than a dictatorship or a de facto kingdom—at least to the extent that greater transparency builds confidence in financial markets and policies enable broader participation in domestic wealth creation.
TGR: Some companies have had problems with the government in the Kyrgyz Republic, including getting permits for gold mines.
James Passin: The political landscape in the Kyrgyz Republic is very difficult to navigate.
Mongolia is the 18th largest country in the world by size. It's sitting on the continental subduction zone between the Asian and Indian subcontinents. It hosts some of the world's most prolific mineral belts with some of the world's largest known undeveloped mineral deposits, some of which are just beginning to get into early phases of production. The exploration is just scratching the surface.
Some geologists talk about the possible existence of 20 or 30 Oyu Tolgoi-type deposits in Mongolia—not to mention the other minerals from iron to uranium to silver to molybdenum. There are also remnants of a sea, the origin of coal-bearing sedimentary basins, with projected 100 billion tons (Bt) thermal coal and 30 Bt coking coal, as well as hydrocarbon potential.
The mineral potential is already in the trillions of Dollars and the true value is probably in the tens or even hundreds of trillions of Dollars. It really is an incomparable destination for strategic investors.
TGR: Another major factor is that very little of the country has been exposed to advanced exploration techniques.
James Passin: Many of the existing surveys were conducted by the Soviet Union 50 years ago, when surveying exploration technology was quite primitive. Some of the new tools are very powerful, leading to the ability to make new discoveries and to drill to deeper targets at lower costs. New satellite tools can even conduct imagery from space.
Our private equity business has control of certain mineral exploration licenses and has conducted a number of exploration programs. My personal experience is that the application of modern exploration technology and practices to exploration programs in Mongolia has led to very significant discoveries. The size of Mongolia is so vast that the new generation of exploration is just starting.
TGR: Has the development of Oyu Tolgoi (which translates to "turquoise hill") put Mongolia on the radar screens of investors?
James Passin: Absolutely. The long-term increase and capture of new employment and the feedback effects of all the economic activity will have an unpredictable impact on the Mongolian economy. It will cause interest rates to trend down and make funding costs cheaper, which will lower hurdles for businesses and enable them to fund more marginal projects and business opportunities in all sectors. That will result in more tax revenue for the government to build infrastructure, including rail, road and power transmission and distribution, which will help to lower the cost of manufacturing and transportation costs, which will help to boost productivity.
There will be more and more world-class mineral deposits defined, discovered, developed and brought into production. That will trigger the development of all kinds of related businesses that will benefit from the higher level of economic activity. This feedback effect is going to drive the exponential real compounding growth in Mongolia's GDP. It will also lead to one of the greatest increases in GDP per capita in world history over a relatively short period.
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