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The
pitfalls presented by a nation’s political environment have long been a
source of concern for natural resource stock investors. In recent years, this
form of risk has increased in importance, particularly when companies set up
shop in less developed areas of the world where bribery is more common and
the rule of law is less respected. The instability created by the financial
crisis of 2008 has created a less predictable world, as governments become
increasingly desperate for cash to pay off unaffordable entitlements, which
populations, in turn, refuse to scale back. As a result, mining companies,
who are often unpopular with the general public, have become bigger targets
for nationalization as a means of bridging an ever tightening fiscal gap.
In recent months,
Argentina has become the new poster child of the anti-capitalist Left, with a
series of hostile government actions declared against
“neoliberal” policies. In terms of definition, the term
“neoliberal” is almost a wash, considering how many variations in
meaning it has; nevertheless, its significance can be loosely characterized
as a constellation of “laissez-faire”, free market, capitalist
principles, epitomized, in a general sense, by the policies of Margaret
Thatcher and Ronald Reagan. In mid-April, President Cristina Kirchner
announced the nationalization of YPF, a domestic energy company that belonged
to Spain’s Repsol, to a standing ovation.
Amazingly, the bill was supported by 81% of the Argentinean congress, an
overwhelming majority that included the support of several opposition
parties. According to the Telegraph, the move was celebrated by
fireworks, song and dance.
Hundreds
were also allowed inside the chamber [of congress]. Together with
politicians, the majority of whom wore YPF badges, they sang in support of Mrs Kirchner and draped a giant banner of Néstor Kirchner, her late husband and predecessor
– who led Argentina away from its neoliberal model of the 1990s –
from the upper balconies of the chamber.
The
takeover of YPF seems to be part of a larger, unapologetic agenda by the
Argentinean government to reject free market principles when they are
interpreted as working against the public interest. According
to Bloomberg, President Kirchner has also seized $24 billion in private
pension funds, while the Telegraph reported on June 5 that the country is
launching criminal proceedings against UK oil companies operating off the
coast of the Falkland Islands. And though this might make local politicians
feel good about themselves in the short term, the
fallout can be pretty dramatic. From January to June, Argentina only received
$2.4 billion in foreign investment, while neighboring Brazil received $44.1
billion and Mexico received $10.6 billion. Meanwhile, companies operating out
of the country are suffering collateral damage as a result of the takeover.
Argentina based Extorre Gold has seen its share
price drop from a high over $6.49 on April 2 to a low of $2.28 on May 16 on
fears of a government takeover, while bluechip
uranium producer Cameco recently terminated a joint
venture agreement with Calypso Uranium Corp., also based out of Argentina,
after two years of investment and collaboration.
Significantly,
central planners have also imposed restrictions on imports into the country
in favor of products made in Argentina, while forex
controls have been imposed to reduce the outflow of money outside of the
country. This is leading to the country’s return to its previous
reputation as a “banana republic” a mere decade after a
hyperinflation that sent many of its citizens abroad in search of
opportunity. History may repeat, as the Argentinean central bank reported that $483 million in foreign currency reserves
had left the country in the span of a week at the end of May. With the rise
in discontent among the world’s populations and the increasing
polarization of the political spectrum, one has to assume that the Argentinean
model could be repeated elsewhere in South America, as well as in Africa,
although perhaps for different reasons.
In many
parts of the world, the threat of war remains constant and real. Whereas
hard-left socialism is the big risk in Latin America, in certain regions of
Africa, the risk seems to be primarily concerned with regime instability and
war, as different clans vie for control of the continent’s vast mineral
wealth. Take Mali, for example, which suffered a government coup in March 21
that reduced gold producer, Avion Gold from $1.37
on March 21 to a low of $0.46 on May 23. According to the Financial Post, the once promising
company has now “delayed its mill expansion because of the
uncertainty”.
The
downside of political risk has always been a key component factor when
investing in natural resource companies, but it seems to have become a more
commonplace concern in recent months, both for companies and investors.
Today’s heightened sense of volatility doesn’t favor politically
risky environments, and one can expect companies in North America and Europe
to begin trading at ever greater premiums relative to their less reliable
counterparts. Argentina is a particularly blatant example of government
overreach, but, in a larger context, it also shows the risks of democracy.
How do companies make long term plans, such as building a mine, when a new
government can change the rules every few years? All to say, they’re
called “emerging” or “developing” markets for a
reason, and, until a greater appreciation for the rule of law is achieved,
companies working in these jurisdictions should be valued in that context.
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