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The Great Mongolian Gold Rush

A Canadian company has staked a claim to $72 billion of copper and gold that it wants to sell to China. First, it needs financing, and a paved road.

Even by the standards of Mongolia, where 2.7 million people occupy an area almost three times the size of France, the Oyu Tolgoi mining camp in the Gobi Desert is a lonely spot. The capital, Ulan Bator, is 550 kilometers (342 miles) away. The nearest neighbor Canadian geologist Charlie Forster can see from his perch atop the bluish-tinged rocks out- side the camp is a nomadic herder who’s pitched his felt tent, or ger, and is grazing goats and camels on the sparse grasses that sprout in the barren, flat terrain. “This place may seem remote,” says Forster, 57. “But it’s not remote from China.”

Oyu Tolgoi—Mongolian for Turquoise Hill—may contain $72 billion worth of copper and gold, one of the world’s largest discoveries, according to estimates by AMEC E&C Services Ltd., an engineering consulting firm based in Vancouver. Forster and his boss, Chicago-born Robert Friedland, chief executive officer of Vancouver-based Ivanhoe Mines Ltd., want to extract the deposits and sell them to China—the world’s biggest consumer of minerals—whose border is just 80 kilometers away.

“It’s a once-in-a-lifetime opportunity,” says Friedland, 54, who travels in a Gulfstream V corporate jet and whose 34.5 percent stake in Ivanhoe was valued at 757.2 million Canadian dollars (US$603.2 million) based on its Oct. 12 price of C$7.51. “Just as Canada is a big, cold country that exports raw materials to a big southern neighbor, Mongolia is a big, cold country that has the biggest southern neighbor.”

Getting the copper and gold out of the ground and shipped to Mongolia’s southern neighbor will be a challenge: As of now, there’s no rail or paved road to the border, and there’s no government financing for one either. A feasibility study outlining how much of the minerals will be economically recoverable when mining begins in 2007 won’t be ready until the first quarter of 2005. Landlocked between Russia and China, Mongolia is connected to the outside world by a branch of the 7,865-kilometer trans- Siberian railway that links Moscow with Beijing—and the nearest station is 360 kilo- meters from Oyu Tolgoi.

“The question is not just Mongolia’s mineral resources and its proximity to China,” says Victor Flores, a New York–based commodities analyst at HSBC Securities USA Inc., a unit of Europe’s biggest bank by market value. “What’s more important is whether the government can provide the platform for companies to invest long term. Mongolia’s done well so far, but Oyu Tolgoi will be a key testing ground.”

‘Our ancestors kept these resources for thousands of years,’ Mongolia’s prime minister says. ‘Now is the time to use them.’

Those betting that the government will succeed include Rio de Janeiro–based Cia Vale do Rio Doce, the world’s biggest iron ore producer, and Gallant Minerals Inc., a closely held Golden, Colorado–based gold exploration company con- trolled by Mohamed al-Fayed, who owns London’s Harrods Department Store Co. They and other mining companies are drilling into Mongolia’s deserts and grassland steppes, where winter temperatures plunge to minus 35 degrees Celsius (minus 31 degrees Fahrenheit) and miners sleep in gers heated by coal stoves.

Apart from copper and gold, Mongolia’s Mineral Resources Authority says, the country has potential coal reserves of 100 billion tons—if correct, equal to almost 10 percent of the world’s known reserves. It has 62,000 tons of uranium valued at $3.2 billion at present prices, according to the Melbourne-based Uranium Information Centre. There are also unestimated quantities of nickel, zinc, lead and tungsten.

“Our ancestors kept these natural resources for thousands of years,” says Mongolia’s Harvard University–educated prime minister, Tsakhia Elbegdorj, 41, in his office overlook- ing Sukhbaatar Square, which contains a statue of Lenin as well as one of Genghis Khan. “Now is the time to use them for our development.”

To do that, Mongolia needs foreign capital. Mongolia, from which Genghis Khan’s Mongol hordes set out in the 13th cen- tury to conquer an empire stretching from Korea to the Medi- terranean, is one of the world’s poorest nations today. Until mining became Mongolia’s major source of exports in 2000, much of the country’s foreign exchange earnings came from the cashmere fleece of herders’ goats. Per-capita gross domes- tic product of $440 is less than half that of China, according to data compiled by Bloomberg. The total market capitalization of Mongolia’s stock exchange is just $23 million—one-six- teenth that of Delta Air Lines Inc., the smallest-weighted company in the Standard & Poor’s 500 Index.

In 1997, Mongolia enacted mining laws modeled on those of the U.S., Canada and Australia to encourage investors by allowing full repatriation of profits and pledging not to dis- criminate against foreigners in the issuing of exploration and mining licenses. That same year, another Canadian company, Bre-X Minerals Ltd., went bankrupt, erasing a market value of $4 billion, when its claims of massive gold reserves in Kalimantan, Indonesia, proved to be a hoax.

The fallout from Bre-X deterred investors for years from betting on small mining companies operating in remote Asian locations. While no one is comparing Ivanhoe to Bre- X, some investors wonder how a company with a market value of $1.65 billion can finance development of a mine Friedland estimates will cost $1 billion to build and won’t begin production until 2007. “Everything I hear about the ore body is attractive,” says James Vail, 59, New York–based senior vice president of ING Investments LLC, who manages $500 million and recently sold his Ivanhoe shares. “But I got a little concerned about the cost and the time frame of developing the mine.”

Friedland, whose office is in a fifth-floor walkup in Ulan Bator, a town of crumbling tenements and smoke-belching, coal-fired power plants, has made missteps in the past. In the 1990s, he earned the nickname “Toxic Bob” after a Colorado gold mining company he owned a stake in was accused by the U.S. Environmental Protection Agency of polluting the Alamosa River. The charges were later resolved after Friedland made a voluntary payment to help restore the river.

In 1992, he discovered and then sold a nickel deposit at Voisey’s Bay, Canada, for $3.3 billion, something he may do again with Oyu Tolgoi, says Jacquie McNish, Toronto-based author of The Big Score (Doubleday, 1998), which chronicles Friedland’s life. “Robert’s a great salesman and a consum- mate dealmaker, but I don’t believe that in his heart of hearts, he’s interested in running a mine,” McNish says. Friedland denies that he plans to sell a majority stake in the mine.

In addition to its operations in Mongolia, Ivanhoe is also a partner in a gold mine with the military junta of Myanmar, formerly called Burma. The U.S. bans imports from Myanmar and has frozen the country’s U.S. assets because of human rights violations. Friedland says he first went there in 1971, shaved his head and joined a Buddhist meditation school. “I think American economic sanctions are a con against the children of each country in which they are imposed,” he says, adding that his mine in Myanmar gives great economic benefits to the country.

Friedland’s record hasn’t deterred Gary Armor, a geologist turned fund manager who oversees $2.9 billion at AMP Capital Investors in Sydney, including Ivanhoe shares. “I know his story does not always make very nice reading, but I have dealt with him for three years, and he’s always been straight with me, and we have done very well out of the stock,” says Armor, who sold three-fourths of his holding when Ivanhoe was at C$13 in November 2003 and is now buying back in at C$7. “This is a small company trying to develop a big project, and there are financial issues,” Armor says. “But in due course, it will be financed.”

Ivanhoe’s shares on the Toronto Stock Exchange rose al- most eightfold to C$7 on Oct. 12 from 90 Canadian cents on May 9, 2001, when the company announced it had paid US$5 million for the exploration rights to Oyu Tolgoi. The shares are also listed on the Nasdaq Stock Market and in Australia.

“Ivanhoe is very undervalued,” says Frank Holmes, 49, who manages $1.4 billion as New York–based CEO of U.S. Global Investors and who this year doubled his stake in Ivan- hoe to 1.1 million shares. “We have a model for mining com- panies. They go through the big run-up, then fall 70 percent, and that’s when you buy them. Ivanhoe’s already gone through that correction. Just ring the bell, baby: Now’s the time to buy.” Ivanhoe’s shares reached C$15.15 on Nov. 3, 2003, and fell to C$4.95 on Aug. 9.

China’s huge appetite for commodities such as copper to stoke growth that has averaged almost 10 percent annually for the past 13 years fuels Holmes’s excitement. Last year, China spent $19 billion importing minerals from as far away as Brazil and Chile. This year, China will devour 34 percent of the world’s iron ore production, 31 percent of its coal, 29 percent of its crude steel, 26 percent of its copper, 23 percent of its nickel and 21 percent of its aluminum and zinc, says Jim Len- non, London-based executive director of commodities research at Australia’s Macquarie Bank Ltd.

China’s demand helped lift the price of copper, used in cars, houses and ap- pliances, by 60 percent in 12 months on the London Metals Exchange to a 15- year high of $3,094 a metric ton on Oct. 12. Nickel, used to make stainless steel, rose 41 percent in the same period, while steaming coal, burned by power plants that are struggling to meet demand for electricity in a country where blackouts have occurred in 24 of 27 provinces this year, was up 68 percent. Gold rose 11 percent to $419.30 an ounce.

Vale is looking for copper and coal in Mongolia. On Sept. 13, Vale threw a party in Ulan Bator with samba dancers flown in from Brazil to mark the company’s arrival in Mongolia to search for another “elephant”—mining parlance for a big dis- covery. “When you find one elephant, you often find more,” says José Lancaster Oliveira, Vale’s director of exploration and project development. “And mining here is easier than in Bra- zil. In Mongolia, you don’t have trees.”

Vale and other big min- ing companies are investing on a much smaller scale than Ivanhoe, which has spent $150 million drilling 965 holes totaling 500 kilome- ters. Vale is exploring 11,000 square kilometers (4,247 square miles) in northern Mongolia compared with the 111,000 square kilometers Ivanhoe has laid claim to in the south. Johannesburg- based AngloGold Ashanti Ltd. is exploring in an even smaller area—3,400 square kilometers. Vancouver-based Placer Dome Inc. says it is waiting to invest in a discovery unearthed by one of the dozen small, and mostly Canadian, mining companies prospecting in Mongolia. Toronto-based Barrick Gold Corp.’s interest in Mongolia is a 9.5 percent stake in QGX Ltd., a Waterdown, Ontario–based miner with a market value of $80 million that’s exploring near Ivanhoe’s Oyu Tolgoi.

About 40 percent of Mongolia’s available land has been licensed for exploration or mining.

So far, Mongolia accounts for just 1 percent of the world’s copper production compared with 33 percent for Chile. And that comes from a single, 26-year-old company, Erdenet Mining Corp., which is jointly owned by the Mongolian and Russian governments and is Mongolia’s biggest company.

Gold production has also been small: This year, 100 Mongolian mines will produce 15 tons, or 0.7 percent of the world output, according to the country’s minerals authority. The biggest and newest gold mine is owned by Centerra Gold Inc., which was listed in Toronto last June after being formed from the gold assets of Cameco Corp., the world’s largest uranium miner. Toronto-based Centerra’s Boroo mine, 160 kilo- meters north of Ulan Bator, began production in December 2003 and will extract 200,000 ounces of gold this year, ac- cording to Paul Korpi, Centerra’s vice president for government affairs. Since first selling shares on June 29, Centerra’s stock was up 22.6 percent to C$19 on Oct. 12 from C$15.50.

Before Ivanhoe can begin producing gold and copper, it needs to secure more financing, Friedland says. Ivanhoe’s exploration costs resulted in a US$73 million loss last year on sales of US$90 million compared with a US$31 million loss the previous year. In the quarter ended on June 20, the company’s net loss widened to US$20.2 million from US$19.7 million a year earlier.

Friedland says he’ll be able to raise money to develop the mine through bank loans, which he says he’ll be able to ar- range on the strength of a detailed feasibility study that’s due to be released early next year.

He’s also looking to sell 20–30 percent of Oyu Tolgoi to a strategic investor. Two of the biggest mining companies have already said they aren’t interested. Barrick Gold said in a July news release that it had decided not to invest because Oyu Tol- goi is primarily a copper mine. The world’s third-biggest miner, Rio Tinto Plc, has decided not to invest, Ian Head, a Melbourne-based spokesman, said without elaborating.

That doesn’t worry Friedland, who says his likely partners will be the consumers of his copper. Ivanhoe is in talks about selling a stake to Jiangxi Copper Co., China’s largest producer, and China International Trust & Investment Corp., the country’s biggest investment company, according to Wang Jun, Citic’s chairman; Huang Dongeng, Jiangxi’s company secretary; and Friedland.

Friedland, who has a bachelor’s degree in political science from Reed College, in Portland, Oregon, says he bought 10 percent of Galactic Resources Ltd. in 1984. The company operated a gold mine in Summitville, Colorado, that the EPA blamed for polluting the Alamosa River. Friedland resigned from the com- pany’s board in 1990; Galactic filed for bankruptcy in 1992. Friedland made a $20.7 million lump-sum voluntary payment in 2001 to be used to help restore the river. The U.S. agreed to pay Friedland $1.25 million in attorney fees and acknowledged that no one person was responsible for the pollution. He denies any responsibility for the pollution and says he has recovered al- most $17 million of the money through lawsuits against other companies that were involved in the mine.

In 1992, Friedland and partners founded Diamond Fields Resources Inc., which discovered the world’s largest nickel-copper-cobalt de- posit at Voisey’s Bay, on the Labrador coast of Newfoundland, a year later. In 1996, he sold Diamond Fields to Toronto-based Inco Ltd., the world’s second-biggest nick- el producer, for $3.3 billion after setting up a bidding battle between Inco and an- other Canadian company, Falconbridge Ltd. Friedland walked away with $440 million in cash and stock for his 13 percent stake in the company.

Inco, which had originally projected annual production of 270 million pounds of nickel a year, has agreed to restrict output to 110 million pounds a year following talks with Newfoundland’s provincial government, which wants to prolong the economic benefits, such as employment, after the

mine’s scheduled opening in 2006. In 2002, Inco took a $1.6 billion writedown on Voisey’s Bay.

In 1996, Friedland listed Indochina Goldfields Ltd., which aimed to invest in Southeast Asia, on the Toronto Stock Exchange. In 1999, Friedland renamed Indochina Gold- fields as Ivanhoe Mines. In 2000, Ivanhoe agreed to pay $5 million and to spend $6 million on exploration to acquire the exploration license for Oyu Tolgoi from Broken Hill Proprietary Co.—now BHP Billiton, the world’s largest mining company. In 2003, Ivanhoe agreed to pay $37 million to buy out BHP’s right to any royalty from the mine. Tania Price, a Melbourne-based spokeswoman for BHP, declines to say why BHP sold its stake in Oyu Tolgoi. “We explore and look at opportunities every- where and don’t discuss anything specifically,” she says. Fried- land says BHP was cutting back its exploration budget.

‘This is a small company trying to develop a big project, and there are financial issues,’ a fund manager and geologist says.

Friedland is betting on the stability of Mongolia, a former Soviet Union satellite that has had seven changes of government since democracy activists in 1991 forced the resignation of the pro-Moscow regime and embraced free-market capitalism.

Today, Mongolia is such a close ally of the U.S. that last year it sent 120 soldiers to support U.S. troops in Baghdad—a city the Mongol hordes destroyed in 1258. Washington has provided Mongolia with $150 million in aid since 1991. It has also given the Mongolians Voice of America, which is broadcast on FM radio, and the Washington-based International Republican Institute, an affiliate of the U.S. Republican Party that advises local politicians on the implementation of democracy.

John Poepsel, 39, the IRI’s resident program director, says he’s so optimistic about Mongolia’s political stability and its mineral potential that this year, he invested $5,000 of his own money in Ivanhoe shares.

In June, Mongolia, which had been ruled for the previous four years by the former communists, faced a political crisis when elections resulted in a hung parliament. After two months of negotiations, the parliament, known as the Great Hural, elected Elbegdorj as prime minister. He’s since patched together what he terms a “grand coalition” of all major parties. By early October, Elbegdorj had yet to form a cabinet, although all factions had pledged to support the mining industry.

He is team includes deputy speaker Sanjaasurengin Oyun, 40, who holds a Ph.D. in geology from Cam- bridge University and who worked for Rio Tinto in London until 1998. “Canada and Australia all built their initial wealth on mining before developing other industries,” Oyun says. “We can do the same.” Under Mongolia’s mining laws, Ivanhoe has to pay the government a royalty of 2.5 per- cent of its mining sales. In addition, mining companies have to pay corporate taxes of 15–40 percent.

High on the new government’s agenda is considering whether to accept an offer from China of a $300 million loan to improve road and rail links between the two countries. The city of Baotou, a mineral refining and smelting center in the Chinese province of Inner Mongolia, is 300 kilometers from Oyu Tolgoi. Baotao is linked to Beijing and the port of Tian- jin by rail and to the Mongolian border by a new highway.

Mongolia has to be careful about allowing China to dom- inate its tiny economy, says Elbegdorj, who’s 5 feet 6 inches tall with a sweep of black hair. “This is a concern,” he says. “But we have to take advantage of the fastest-growing econ- omy in the world.”

Last year, Mongolia repaid a $250 million debt to Russia that dated to the Soviet era, thanks in part to Ivanhoe’s buy- ing $50 million of Mongolian government bonds. Friedland says the bond purchase expresses Ivanhoe’s commitment to remaining in Mongolia until the tiny company from Van- couver is as big as its international rivals.

“We are going to become a BHP,” Friedland says. “We are not for sale. We are too good to sell.” As they wait for production of copper and gold to begin in Oyu Tolgoi, Ivanhoe’s investors and the citizens of Mongolia are betting that he’s right.


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