Lomas: Risks in gold projects abroad

Bad global news is generally good gold news. The late 70s was a mixture of high inflation, OPEC’s oil embargo, and wars in the Middle East. Today’s uncertainty over tariffs, along with wars in Ukraine and the Middle East, have pushed the gold price higher, though it’s unclear whether the current price will remain where it is, or continue to rise, or quickly drop 30% like it did in 1981.

This year, optimistic gold mining companies will likely consider stepping up acquisitions, development, and production to benefit from high demand. In advanced countries, regulations and permitting delays will limit how quickly mines can open or expand.

Less developed countries may welcome fast-tracking new mines, but multinational corporations must consider regional risks wherever they go. Low wages and looser safety and environmental standards may enable new operations to get underway more rapidly in some countries than in countries with strict regulations, but some stock funds will not invest in companies with operations that do not meet international environmental standards.

Prior losses abroad have led some companies to analyze the ways that a project can turn sour. Problems may arise when expanding into a new country, and though each country has its own set of risks, companies must consider several basic issues. Companies seeking to produce more gold sooner amid high prices should realize that this is a poor time to cut corners while taking on additional risk.

Nationalization

The biggest catastrophe for a company’s foreign mines is nationalization, when the host country declares that it now owns the operation. Gold mining operations are vulnerable to nationalization because, unlike many manufactured goods, gold’s specifications do not change, and gold is easy to sell and transport.

Countries that have nationalized their commodities include Mexico’s nationalization of its foreign-owned oil operations in 1938 and Peru’s nationalization of a major copper company in 1973. Peru’s takeover of the copper mines in Cerro de Pasco prompted Chile and Zambia to follow suit and nationalize their foreign-owned domestic copper operations as well.

Nationalization is sometimes triggered in countries with struggling economies where a new government wants to appear to be immediately improving the economy. High commodity prices increase the temptation for a struggling government to nationalize some of its foreign-owned mines and mills.

Argentina nationalized several industries in the 1940s and 1950s, but backed away from that practice until 2012, when its new government renationalized the Spanish oil company that had bought operations that had been sold by Argentina’s government. Argentina’s government claimed that the company has failed to invest enough in its Argentine operations while sending its high profits to Spain.

While there are some recent rumblings in South America about taking over lithium deposits, there haven’t been any moves to nationalize existing lithium operations, though Mexico nationalized its lithium deposits in 2022, and canceled its mining agreements with foreign companies. However, lithium wasn’t likely to be produced in Mexico for several years.

Few gold mines have been nationalized recently, except for a Canadian-owned mine that was nationalized by Kyrgyzstan in 2021, and two domestically-owned mines in Africa that were nationalized last year by Burkina Faso’s military junta.

Civil unrest

Wars and chronic regional disputes can halt mining operations, particularly in countries with weak central governments. In 1977, rebels invading a copper mining region of the Congo killed hundreds of mine employees and expats. To a lesser extent, protesters disrupted a major mining city in Ghana in the late 1990s after the local government shot a few illegal miners. Around the same time, a gold mine in Greece suspended its reopening when local protesters blocked trucks from entering the property.

While Ghana’s mines remained in operation, the Congo’s copper mines and Greece’s gold mine halted operations for years following those incidents. Revolutions are unpredictable, and so it’s difficult for business analysts to forecast their impact.

Fraud and theft

Outright fraud in large mining ventures is uncommon, but in 1995, Canadian-based Bre-X announced some extremely high assay results from a remote drilling prospect in Indonesia. That news triggered a huge run-up in its stock price, valuing the company at over $4 billion, as other mining companies rushed to invest in the proposed operation. However, Bre-X’s drill cores were later found to be salted with gold that was never intercepted, and the company collapsed.

Fraud can occur anywhere because investors tend to believe good news without doing a thorough analysis. In 2001, Enron, a Texas-based energy company with 20,000 employees that soared to $100 billion in sales, was found to be grossly exaggerating its earnings and was forced into bankruptcy for accounting fraud, wiping out billions of dollars in shareholder value and causing its auditor, one of the USA’s top accounting firms, to fail.

Those examples occurred 25-30 years ago, though, and many of today’s business analysts were not around then, and may not have experience with fraud’s potential extent.

Gold is easy to smuggle, since a standard 400 oz bar is now worth $1.2 million. Africa alone exports about 300 metric tons of smuggled gold each year, primarily to the Middle East and Switzerland. Most of this gold is produced in illegal mines, but some gold is stolen from legal operations.

Ghana’s largest gold mine had a problem with illegal miners trespassing into its open pit to scrounge shot rock for gold. Its underground operation had to cover rich veins with paint and prevent its mine employees from taking pans and screens underground to pilfer gold while on the job.

Supply theft by employees can also drive up mining costs. While gold may be carefully guarded and tracked in-process, supplies are more difficult to monitor. Local employees tend to get suspected of stealing mine supplies and consumables like diesel fuel, but expats can also work in unison with local employees, as was discovered in an African mine 15 years ago where fuel was routinely siphoned from haul trucks and sold on local markets.

Facilitation payments

In some countries, bribery is tolerated as a system where underpaid employee wages are subsidized, similar to the way that tipping waiters is accepted in the USA.

Bribery burdens business, but it often evolves into a subdued pattern that keeps it at a bearable level. However, business analysts sometimes don’t understand the system well enough to forecast an adequate reserve for those expenses, and these informal compensation plans are even less predictable as gold prices soar.

The USA’s law against foreign corrupt practices is primarily aimed against bribes to government officials, but the law contains an exemption for “facilitation payments.” Despite this loophole, accountants may struggle with how to avoid controversy, since these payments distort operating costs, taxes, and profits, and may expose a company to shareholder lawsuits.

The world’s two largest gold producing countries are now China and Russia, and both countries have significant problems with government corruption affecting many industries.

Reducing risks

With all these potential problems in foreign mines, a corporation should proceed with caution and adopt methods to lower risks.

In many cases, the strategy is to give incentives to the host country’s government to keep the company operating profitably. The company will sometimes share ownership of the project with the host country, while maintaining controlling interest with the company, but allowing the government a large enough share to have a say in major decisions.

Many companies will agree to hire and train local citizens whenever possible, and limit the number of expats on site. Mines pay various taxes and royalties, and may even help provide some local infrastructure development that benefit locals, such as roads, power plants, and internet or cell services.

One major gold corporation has a “sustainability” program that invests at local and regional levels to aid both the host country and the mine. These incentives may be in new businesses that have a favorable return on investment and aid the local economy for the long term.

Some mines adopt a dual management structure, with a resident general manager who exclusively deals with the host country’s political, social, legal, and cultural issues, and an operations manager will only run mining and processing.

The overriding reason for all this is not entirely for the good of society, since a failed project abroad can burden a corporate balance sheet with debt that has no offsetting gold production. Debt can depress corporate earnings and stock prices for years, especially if the corporation may be forced to sell off mines to raise cash to erase its debt, leaving a corporation that produces fewer ounces and less income in the coming years.

Corporations must identify risk in foreign projects by conducting a thorough country analysis before they invest. However, when prices are at record highs, analyses may be compromised by the temptation of boosting earnings through rapid expansion.

A mining project technical analysis may contain hundreds of pages of numbers, while a country analysis for the same project may be hard to quantify. A technically-sound project may fall apart when unforeseen issues arise with the government, local culture, or politics, but additional focus on technical issues does not make up for too little focus on political, social, and cultural issues.