Mongolia: A speculator’s fantasy

February 23, 2011, 3:00 PM UTC

It’s boom time in Mongolia, which had a record $1.4 billion in foreign direct investment in 2010, thanks to its copper, gold, and coal — and neighbor China’s insatiable hunger for the commodities.

Ever heard of the tugrik? It’s the official currency of Mongolia — the land of Genghis Khan where, over the past few years, foreign investors have flocked to the sparsely populated country in search of riches.

It was also the world’s best-performing tender in 2010.

Mongolia’s vast mineral deposits, particularly copper, gold and coal, have helped drive unprecedented demand for the tugrik. The currency finished the year 15% higher against the U.S. dollar, outperforming the world’s currencies and coming close only to the South African rand, which appreciated 14%, and the Australian dollar that rose by 13%.

“When I came to Mongolia seven years ago they had just discovered all these deposits — the buzz was that Mongolia was literally sitting on a gold mine,” says Christopher de Gruben, who in 2004 founded Make A Difference Corporate Services, a Mongolia-based firm that specializes in renovating dated Soviet Union-style homes and corporate relocation home searches. Like many investors, Gruben is hopeful, if not simply in awe, by the country’s vast mining potential and “the boom about to happen.”

Indeed, the tugrik has fast become the best thing no one’s ever heard of. Most major Wall Street banks don’t follow the tugrik, and few economists or analysts track the landlocked country bordered by Russia to the North and China to the South. Not that it would have been easy. Some parts of the country still operate under an informal barter system, paying for everything from food to clothing with livestock and the like. It was only in 2009 that the Parliament of Mongolia closed a loophole allowing the use of any currency for local transactions. Now the tugrik must be used for most domestic transactions.

Bubble trouble?

But it’s hard not to wonder if Mongolia can really be called a new frontier or merely a temporary bright spot ripe for get-rich quick investors. “People are getting rich very quickly,” Gruben says, pointing to the Louis Vuitton (LVMHF) store that opened in Mongolia’s capital Ulaanbaatar in 2009 as evidence. “There’s this whole race about who has the fastest car and who has the most money here.”

The country is one of several relatively poor economies that have seen their currencies rise as the price of commodities rebounds mostly from demand from China. The price of copper, Mongolia’s chief export, fell by as much as 65% from $8,700 per ton in April 2008 to $3,000 per ton in March 2009. It has since recovered in a big way, with the commodity expected to trade at $11,000 later this year, according to Goldman Sachs.

So it’s no surprise that investors have tried to cash in on a return of the good times. Foreign direct investment likely hit a record high, exceeding $1.4 billion in 2010, according to estimates from a recent report by Eurasia Capital.

In October 2009, Mongolia’s government passed long-awaited legislation on an agreement to develop the Oyu Tolgoi mine, considered one of the world’s largest untapped copper and gold deposits. In a way, the deal has given international investors some confidence after Mongolia’s government bailed out one of the country’s biggest banks. When production at the Oyu mine moves to its peak, the mine alone is expected to boost Mongolia’s GDP by an unprecedented 20% to 30% between 2013 and 2014.

Recently, mining and resources company Rio Tinto Group (RIO) announced it will take over management of the Oyu Tolgoi project after agreeing to invest as much as $3.7 billion with partner Vancouver-based mine operator, Ivanhoe Mines Ltd. Though one of the largest, Rio’s investment is one of several expected to come into Mongolia.

But just as the rebound in commodities has helped Mongolia recover from the global recession, it can surely take them down again. It was one of the East Asian economies hardest hit by the economic downturn. What’s more, it’s perhaps one of the most vulnerable to the volatility of commodity prices. Prior to the downturn, Mongolia grew an average of nearly 9% per year largely due to high copper prices and new gold production. In 2009, GDP dropped 1.6%.

Indeed, most economies with vast minerals suffered as commodity prices fell. But Mongolia was especially vulnerable compared with some of the world’s largest copper exporters. The problem was partly because the country’s government didn’t save enough during boom times, leading it to run a budget deficit in 2008. Copper exporters Chile and Papua New Guinea, on the other hand, had run large fiscal surpluses during boom times.

Mongolia might certainly be a new frontier, if not just for its vast minerals but also its central location near resource-hungry China. The way it will grow, however, will be something to watch for. And almost certainly something to question.

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