Perhaps interest in Mongolia hasn’t run this high since Genghis Khan and his descendants roamed far past the steppes of Eurasia nearly 800 years ago, sweeping to conquest on all sides. Back then, the united Mongol Empire swallowed territories from China to Europe and Russia to India, even part of the ancient Silk Road—named for the lucrative silk trade with China—as part of its vast land holdings.
Now, however, the launch of a new ETF from Global X Funds indicates growing investor interest in the country. The Global X Central Asia & Mongolia Index ETF (AZIA) seeks opportunities presented by central Asian countries, including Mongolia, and their close trade ties with China, as well as their rich natural resources. Opportunities are there aplenty, though the road is far from smooth.
Russia and China are far from the only outside nations exploring opportunities in Mongolia. The Anglo-Australian mining company Rio Tinto is deeply involved, in the wake of 2009 legislation that advanced an investment agreement to develop the Oyu Tolgoi mine, thought to be one of the world’s largest unmined copper deposits; it is also rich in gold and silver. Output from the mine is expected to boost the country’s GDP by 33% once it’s fully operational, with an ore deposit that runs for 20 miles beneath the sands of the Gobi Desert—comparable in size to Manhattan. The yield is expected to reach 330,000 ounces of gold annually, and an even more spectacular 450,000 tons of copper.
Rio Tinto has already spent more than $6 billion in development on Oyu Tolgoi (the name means “turquoise hill” in Mongolian), through its Turquoise Hill Resources unit. The Chinese aluminum firm Chalco bid on a majority interest in SouthGobi Resources, which mines coal from Tavan Tolgoi, another huge Mongolian mine. Toronto-based Kincora Copper owns the Bronze Fox copper-gold deposit. Mongolrostsvetmet is a joint venture between Russia and Mongolia, mining fluorspar, gold and iron. Other countries mining in Mongolia include Thailand, Hong Kong, Germany, the U.S. and Switzerland.
But here’s the rub: in mid-2012, a resource nationalism effort to retain more income and resources from its mines led Mongolia to change its laws, and outside investment dropped by 17% for the year. From Mongolia’s point of view, the new laws made sense, since currently coal from Tavan Tolgoi costs more to mine and deliver than Mongolia makes from its current agreement with Chalco. In addition, as its agreement with Rio Tinto is currently written, Mongolia stands to make no royalties from Oyu Tolgoi until Rio has recovered its investment, which could take years.
Mongolia suspended SouthGobi Resources’ mining licenses last year after Chalco’s bid, and followed with a law restricting foreign ownership of companies in strategic sectors, including mining, to 49%. In addition, coal delivery to Chalco was halted in January as Mongolia sought to renegotiate contract terms. In February, Rio Tinto threatened a delayed launch of the Oyu Tolgoi mine in a dispute with the government. Funding requirements in a stage-two mining report by the company reflect an inflation rate of some 30% in building costs for the mine, and neither the government nor the company are satisfied with the investment agreement as it stands.
A new minerals law has also been proposed that would allow the government to change tax rates on mine leases, take back leases that provide limited compensation, and gain free rights to shares in strategic mineral deposits. The proposal has not been welcome news to mining companies, whose shares plummeted on the government’s actions.
Now, however, the government is wooing companies and investors back. Among new measures proposed to ease the way for foreign companies to do business in the country is the removal of a requirement for Mongolia’s parliament to review minority investments by private companies. State-owned companies, however, would still be required to undergo a parliamentary review.
The country has also said it intends to legislate on investment to stabilize tax rules and avoid frequent change. In addition, debate on the proposed minerals law has been postponed till June.
The original prospectus for Global X’s AZIA ETF was filed more than a year ago—prior to the Mongolian government’s restrictive resource nationalism actions. With its new ETF barely a week old, research analyst Alex Ashby from Global X said that the current negotiations and disputes on regulation create an atmosphere that the firm is watching closely.
Still, “Mongolia is predicted to be a pretty high-growth country this year and obviously a portion of that is related to the natural resource production and demand from China, so that’s the strongest link. Growth in Mongolia is hinged pretty solidly on increased and continuing demand for resources in China. So even when growth slows down a little bit, [China is] still such a huge consumer of natural resources that Mongolia could be a very strong partner,” Ashby said.
Since the ETF investing is index-based, it’s in for the long haul. “When we move forward with a product, we have a long-term view in mind as to what we think macro drivers will be in the future. Growth in China, the middle class there, and the consumption of natural resources [add up to] a trend we think is stronger in the long term. We see longer-term growth for investors with a longer-term horizon,” Ashby said.
The ETF invests not in Mongolian companies, but “in companies that are headquartered in or have operations in Mongolia and central Asia, or get significant income from there,” he said. And while opportunities abound, the firm is keeping a close eye on developments.
“It’s a tricky situation for such a young government and a young democracy, in trying to balance the involvement of foreign countries that manage the natural resources, and make sure that the country also benefits proportionally from those investments and resources,” Ashby said.
“It’s definitely an area people are going to be looking at—that we’re watching in Mongolia and [elsewhere in] central Asia as well. There’s going to be some back-and-forth, but in the longer term, the country will want these companies operating there, and companies will want a clear and enforceable set of guidelines and rules that they can operate under. Negative developments have been reflected in past announcements—Rio Tinto and others—and had an effect on stock prices and companies. It’s definitely an issue that we’re watching,” he said.
After all, silk wasn’t the only thing that traveled the Silk Road. So did bubonic plague.