Mongolia's gold-reserve boosting experiment

Mongolian special: lower tax for gold reserves. We look more closely at the implications of a new royalty law that has been recently introduced.

Author: Kip Keen
Posted: Wednesday , 12 Feb 2014 
In late January Mongolia made law an amended gold royalty regime that lowers a gross tax on gold sales to 2.5 percent from up to 10 percent if a gold miner sells its production to the central bank. It's a fascinating gambit by Mongolia to boost the size of its gold reserves, confidence in its inflating currency and growth of its official gold mining industry, which, according to reports, produced a modest 290,000 ounces gold in 2013, the vast majority of it exported.
Already one of Mongolia's top gold miners, Canadian-based Centerra Gold, has put the new law to work. Centerra Gold spokesperson John Pearson, the company's vice president of investor relations, confirmed a research report by Dale Choi, who runs the firm Independent Mongolia Metals & Mining Research, that it has sold 100 kilograms gold to the Mongolian central bank under the new tax regime last week (this is roughly 3,200 ounces or $4 million worth of gold at presstime) . 
"It's very attractive," said Pearson of the amended law. 
Centerra's gold sale to the Mongolian central bank - from its Boroo gold mine where it expects to produce 45,000 ounces gold this year - stands as an important test of the new system, which, if the buying continues, gives Mongolia a highly attractive royalty regime and suggests more legislative progress in favour of miners in a country that has in recent years made administrative decisions that torpedoed foreign direct investment.
Choi, in an interview from his Ulaanbaatar office on Tuesday, expressed optimism in the direction Mongolia's government was taking, although there are major decisions still hanging in the balance for Mongolia to address, ones to which miners are paying close attention. These include a mineral law that explorers hope will thaw the moratorium on exploration licenses and resolve 106 exploration licenses - or some of them - that were recently rescinded, agreement with Rio Tinto on the Oyu Tolgoi underground project and approval of Centerra's Gatsuurt gold project (ore from which it hopes to process at Boroo). 
But with the new and lower royalty tax coming on the back of a new investor protection law, Choi said, "Something has been done and both parties agreed to it." He credited, in part, Zandaakhuu Enkhbold, the speaker of the Mongolian parliament who he praised as a "tough little fellow."
The lower royalty rate - assuming the Mongolian central bank can keep buying gold - could help attract investment, or set the stage to do so once other issues are resolved, in a democratic country that has damaged its reputation as a destination for mining investment in recent years and is known for extensive corruption.
Still, there are questions to consider as regards the stability of the new gold royalty regime: First, with a thin foreign exchange market, to what extent can the country handle currency conversions? And second, how will the Mongolian central bank fund gold purchases if such sales boom? 
As Choi put it, the law and its implications are not "straightforward."  
1. Gold miners, especially foreign ones, will want to convert a good portion of proceeds from gold sales to US dollars out of Mongolian tögrög, with which the Mongolian central bank pays. Certainly they will keep some money in country in local currency to fund domestic operations. But equally certainly they won't want to keep it all there, especially given recent high inflation versus the US dollar.
The currency market looks like this: Choi estimates that daily volume of trading US dollars in Mongolia is between one to five million dollars. Miniscule in the grand scheme of things. The question becomes how well the system - and miners - handle large gold sales and subsequent currency conversions in a dollar-constrained market. Miners will have to be smart about sales, Choi noted.
In this respect, Centerra's Pearson said the gold miner had tested this aspect of the equation through its gold sale to the Mongolian central bank. It converted a sizeable portion of the proceeds from local currency to dollars, he said, and it worked very well. That should provide some faith Mongolia is serious about growing its gold reserves under the new tax regime. 
But at the same time it's fair to say the system has yet to see a deluge of miners chasing dollars, stressing the currency exchange market.
2. There is also the question of Mongolia funding gold purchases, especially if they grow. Mongolia wants to boost confidence in its currency, turning to gold, but to do so it may have to dilute its cash pool, that is, as Choi noted, print money; and this in a country fighting inflation, often in the teens, with a depreciating currency and a bond market sceptical of government issues. 
"I'm not quite sure what's going to happen," Choi said in context of how the amended mineral law would unfold in practice. Still, he was optimistic. Mongolians love gold, Choi said, and increasing reserves would boost faith in the Mongolian tögrög.


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