The Importance of Politics in Mining
When evaluating a gold mining company, the natural question that arises when comparing mining reserves is: How much gold can you find? This seems like it would be a reasonable filter to separate companies. The reality of the gold mining value matrix is more complicated, however, and the of “How much” is not nearly as important as a different question: “Where are the mines?”
Mining reserves in all countries are not equal. Why? Because there is an ambiguous firewall between gold in the mines and dollars in the pockets of investors: governments. Because gold is a physical resource that must be mined and then sold, moving gold across country borders can be subject to various tariffs. Converting gold to currency is subject to free trade. Moreover, converting local currency to US dollars is again subject to governmental regulation. Ok, so we can all make the apparent logical argument that less government regulation and tariff is the deciding factor between so called “good” countries and “bad” countries, right? Well, kind of.
Ideally, from an investor’s perspective, countries would allow companies to buy(or the right to mine in) land with ample gold and then create little barrier to transferring that gold into US dollars. This process does work in several countries, such as Canada, where the monetization of gold is more unencumbered by governmental policies. [Update: However, it is important to note that Canada’s Metal and Diamond Mining Effluent Regulations (“MDMER”) were amended on June 1st, 2021, which altered the regulation of effluent discharged from both new and existing metal and diamond mines.] So other countries just charge more at the transaction points and that is all I need to worry about? Again, kind of.
There is one more giant risk that often goes unmentioned: nationalization.
What does this mean? Nationalization of gold mines occurs when countries declare ownership of previously privately owned mines. Countries, being ultimate agents of action, can declare governmental ownership of entities that operate within their borders. Once outside companies endure the risk of identifying profitable gold mines, governments can declare the mine to be governmental property, thereby hijacking the intellectual and mechanical energy deployed by the outside company and abruptly declaring full ownership of the mine.
Does this risk actually exist or is this fantastical hyperbole?
[Update: Barrick Gold and a Chinese partner have challenged Papua New Guinea’s apparent move to grant a 20-year lease for the Porgera gold mine to a state-backed firm. Barrick Gold Corporation and EarthRights International (ERI) have also negotiated a settlement of claims by 14 individuals from Papua New Guinea (“PNG”), represented by ERI, in relation to a variety of alleged acts of violence concerning the Porgera Mine in PNG.]
Papua New Guinea has recently threatened to revoke its special mining lease with Barrick Gold, essentially declaring seizure of the Porgera gold mine despite the heavy revenues received by the country from corporate taxes paid by the mining company. This risk has become so severe that Barrick and its affiliate Chinese partner, Zijin Mining, have suspended mining operations. (Financial Times, April 28 2020) Despite being a “tier one” asset and rising gold prices, this mine has been shut down due to the risk of governmental interference. Similar battles have been waged between Glencore and the Zambian government during recent Covid related shut downs. Companies that retain mining leases are heavily dependent on the stability and honesty of the governments from whom they lease.
[Update: In terms of nationalization cases since 2020, resource nationalism has been on the rise in top mining countries. This can take several forms including renegotiation of existing mining contracts to get better terms (currently witnessed in DRC and Mongolia), increase in taxes or royalties on the mining sector (Chile, Peru, Russia), asset nationalization (forced equity transfers) or threat thereof (Zambia, Mexico, Zimbabwe), in-country beneficiation (Indonesia), or export restrictions.]
Is there some index that allows me to see if I’m dealing with a “good” government or “bad” government? Kind of.
Let’s talk about SWAP lines, which are explained in more detail here by Katusa Research.
Although governments can exercise control over their mines and currencies, they are at the bargaining table when it comes to access to another commodity: US Dollars. Though the Fed is printing money at unprecedented speed, most countries are constantly struggling to obtain and maintain access to US Dollars and this is a topic that has been well published in economic literature. There is an emerging shortage of US Dollars worldwide and countries are begging for access to convert local currency into Dollars. Here is where the US can push back-the US has created this agreement among central banks called Swap lines, which allow for an exchange of currency at the market rate.
Can every country get a swap line? Nope. As an added measure of protection for US investments in foreign countries, the US forces countries to honor fair trade agreements in order to have access to the almighty US Dollar. As it is written on the Federal Reserve’s website, one of the pivotal roles of swap lines are to support “foreign economic conditions, which also positively benefit the U.S. economy through many channels, including confidence and trade.” Basically, the US is trading access to the dollar for countries to waive the right to be a jerk. Which countries are included in the SWAP agreements?
[Update: In terms of SWAP lines, there have been some changes since 2020. On 19 March 2020, the Fed renewed its dollar liquidity swap lines to nine central banks at twice the 2008 limits and enhanced its existing unlimited swaps to Canada, Japan, Switzerland, and the ECB. In July 2020, these swap lines were renewed until March 2021.]
See the map below? All those countries in Yellow have standing agreements and the ones in red have temporary lines for additional funding. Do you notice a pattern? Yes, it is our allies that have the most plush access to US Dollars. You can see that our friends in China and Russia aren’t included along with Papua New Guinea.
What does this mean for the investor that is evaluating gold mining companies? Make sure the mines are located in countries that are competing for access to US Dollars as they are incentivised to play nice with foreign companies and investors. Where is an ideal location for mining? The US and Canada for starters….
[Update: The COVID-19 pandemic has had a significant impact on the mining industry. Mining companies have been affected by COVID-19 outbreaks, and global restrictions to encourage social distancing have meant that mining projects have either slowed or been put on hold until further notice. However, it has also created opportunities for mining-related companies to generate value by revising their business plans.]
When evaluating gold mining companies, it is crucial to consider not only the amount of gold reserves but also the location of the mines. The political climate, the stability of the country, and the relationship with the US all play a significant role in determining the success and profitability of a mining operation.
Countries with access to US Dollar swap lines and a history of honoring fair trade agreements are generally safer bets for mining investments, as they are more likely to maintain a favorable environment for foreign companies and investors. The United States and Canada are prime examples of countries where mining operations can be conducted with fewer risks associated with political interference and nationalization.
However, it is essential to stay informed about the latest developments and changes in the mining landscape, as the industry is continually evolving. New tariffs, regulations, and geopolitical events can significantly impact mining operations, making it crucial for investors to stay up-to-date with the latest information.
In the current global context marked by the COVID-19 pandemic and the rise of resource nationalism, it has become even more critical for investors to carefully assess the risks and potential rewards associated with gold mining companies. By considering the complex interplay between politics, economics, and mining operations, investors can make more informed decisions and navigate the challenges of the gold mining industry.
