Doug Casey and I used to discuss the odds of local politics turning bad, say, in Mali or El Salvador. And then the next day, it would be Quebec or some other pro-mining jurisdiction that would raise taxes on miners. Doug would chuckle and say, “You can run, but you can’t hide.”
By that he didn’t mean that we should give up. He meant that mineral exploration, development, and even extraction is a business at high risk of intervention and extortion from politicians—everywhere in the world.
There is no such thing as a politically risk-free resource play.
But the resource sector is the best hunting ground for 10-baggers, 20-baggers, and even the legendary 100-baggers. The next one is out there, waiting.
Which brings me to a key lesson I learned from Doug. At some point…
Price Trumps Risk
Let’s say there’s a billion-tonne copper deposit in a relatively safe place like Canada. It’s got good grade, a gold credit, and the mineralization starts right at surface. There’s even a feasibility study on it that shows a high net present value (NPV) and an excellent internal rate of return (IRR). Politicians willing, the project is an excellent candidate for a long-lived, highly profitable mine. The exploration company that owns it has work to do, but is making good progress and trades at a market valuation that fluctuates around half of the NPV.
Now let’s say there’s another company also making good progress on a deposit with very similar characteristics. It has almost the same NPV and IRR. But this one’s located in the Democratic Republic of the Congo (DRC).
It would come as no surprise for the market valuation of the company with the project in the DRC to trade at a discount compared to the one in Canada. Given the trouble over “conflict minerals” there and that the government has changed the rules on miners before—not to mention that the place was a bloody war zone not too long ago—it makes sense. I wouldn’t want to invest there unless the stock was selling so cheaply, it was worth the risk.
How cheap would that be? Unfortunately, there’s no magic formula. If the Canadian project trades at 0.5 x NPV, should the DRC project trade at 0.25 x NPV? 0.1 x NPV? There’s no coefficient of political risk that one can plug in to an equation to get the right answer.
Actually, back in my Casey days, I did develop a “Casey Country Score” based on World Bank business environment statistics, the Fraser mining survey, Fraser’s Economic Freedom of the World Index, and inflation and other economic stats. This was an interesting exercise, and it correlated well with my perception of the risk to investors in various countries—better than the Fraser mining survey alone. But I never even considered trying to create a valuation formula from it. It’s just not that simple. Among many other reasons I wouldn’t have trusted the results of such a system is that the political risk is not uniform across entire countries. It is just not possible to measure such risk on a town-by-town and region-by-region basis.
Instead, I’d start with the idea that anything trading for 10 cents on the dollar or less was worth a look. I might go considerably higher than that if a country had a bad reputation but had shown real signs of being more pro-business. It was and remains very much a case-by-case decision, based on the nature of the project (big open pits tend to meet more resistance), management’s track record in difficult countries, and my take on the specific, local political climate. This is one of the main reasons I like to travel to see (kick the rocks, as geologists say) projects before I invest in them.
Even then, I made some bad calls. I am human. But I also made some spectacular calls—even in the DRC.
There were, however, some countries I wouldn’t—and still don’t—invest in, regardless of price. That list includes:
- Bolivia
- Kyrgyzstan
- Russia
- South Africa
- Venezuela
More generally, it takes a huge discount to interest me in a resource project in almost any part of Africa, Central America, India, and the “stans” in Eurasia.
The richer countries in Western Europe aren’t very attractive in this sense either, though poorer countries on the European periphery can be great.
North and South America can be great or terrible, depending on local circumstances.
Again, I take them on a case-by-case basis. And it really is important to go check out the situation in person. You can’t trust what you read online, pro or con. And I never take management’s word on local politics, as a matter of principle. That’s even true for people I’ve known for many years and like. I always want to go, explore, and make my own judgment.
I have literally worn out boots doing this.
That’s why they call me the Due Diligence Guy. By the way, if you’re interested in more of my everyday thoughts, adventures, and findings, you can follow me on Twitter: @DueDiligenceGuy. And, of course, if you want to know where I’m investing my own cash—both countries and specific stocks—you should subscribe to the Independent Speculator.
Meanwhile, as I commented last week on the news from Indonesia, I’ll do my best to keep readers of this free service posted on significant events regarding political risk for investors.
