The ballad of Kumtor Gold

It’s better to own commodities than commodity stocks

Jakub Rehor


August 23, 2021

Central Asia is the region between the Caspian Sea and China, bounded in the north by Russian Siberia and in the south by Iran and Afghanistan. In the old days, it was known under the names of Transoxiana or Western Turkestan. It was inhabited both by nomadic herders who roamed the steppes and by urban populations who cultivated fields irrigated by the waters of the Amu Darya and the Syr Darya. The herders spoke Turkic languages of the Kipchak branch, while the more sophisticated urban dwellers used Persian or Chagatai Turkic. There were no nations in the modern sense; people derived their identity from their village, their clan, or their tribe.

When Russia conquered Central Asia in the 1860s and 1870s, it didn’t disturb the local fabric. Russian rulers contented themselves with creating small European quarters within the cities, usually with an Orthodox church, a train station, and a military garrison. Outside of the Kazakh borderlands near Siberia, Russians didn’t settle in the countryside. The tsar replaced the local emirs but life mostly went on as before.

Everything changed with the Bolshevik revolution. The People’s Commissar of Nationalities, one Joseph Vissarionovich Stalin, was full of opinions about what a proper nation should look like: he even wrote a treatise on the subject called “Marxism and the National Question”. Central Asia didn’t resemble his theories at all. Too bad for Central Asia! The Bolsheviks rolled up their sleeves and proceded to create proper nations from the unpromising jumble of clans, tribes, and settlements. Communist linguists declared that Persian speakers were actually members of the Tajik nation and Turkic speakers were Uzbeks. Similar discoveries revealed other, heretofore unknown, nations of Kazakhs and Kyrgyz and Turkmens. Each was allocated a territory, a capital, an academy of sciences, and a national branch of the Communist Party of the Soviet Union: in other words, everything that a nation needs. No matter that there was no way to draw meaningful borders between hopelessly jumbled and mixed up linguistic communities. No matter that borders were cutting across valleys and that mountains split countries in two, that roads from one part of the country had to pass through the neighboring country to reach their destination. None of this mattered in the Soviet Union anyway.

The collapse of the USSR in 1991 turned these phantasms of Communist imagination into actual countries. They were quite unprepared for this surprise: Kazakhstan, for instance, was the last Soviet republic to declare independence, months after everybody else left. The local Communist Party bosses declared themselves presidents, rigged up fake elections, bolstered their power base by drawing on their regional and clan ties, and proceded to plunder their countries in a breath-takingly brazen style, complete with 250 foot tall rotating statues of themselves. No wonder that discontent quickly erupted in protests, massacres, and civil wars.

Into this morass waded, in 1992, a Canadian company. Formerly a government-owned uranium mining enterprise, Cameco (short for “Canadian Mining and Energy Corporation”) was privatized in 1991. Emboldened by IPO money burning a hole in their pocket, the Cameco management felt that Saskatchewan was no longer big enough to contain their ambition. They gazed in wonder upon the world and set their sight on a mountain in Kyrghyzstan.

Soviet geologists found gold deposits in the Ak-Shyirak range of the Tien Shan mountains in 1978. They deemed them uneconomic: the altitude of the deposit, at 4,000 metres, was higher than any mine ever built (the similarly elevated Yanacocha mine in Peru lay still in the future). The Saskatchewan flatlanders, however, were unfazed. Tien Shan is really no different from Cypress Hills, only taller. Cameco signed an agreement with the government of newly independent Kyrghyzstan to develop the deposit, christened Kumtor Gold. To their credit, they did a bang up job and the mine started producing gold within five years.

Kyrgyzstan held greater promise as an investment venue than the other Central Asian republics. Its president, Askar Akayev, was the only Central Asian leader who wasn’t a former Communist Party apparatchik: a physics professor, he ended up in the presidential post as a compromise candidate when two Party bosses arrived at loggerheads. Akayev promoted privatization, market economy, and Adam Smith over Karl Marx. There was talk of Kyrgyzstan as the Switzerland of Central Asia.

Unfortunately, the optimism turned out to be without merit. After two rigged elections and an increasing stench of corruption, Akayev was ejected from power by a Tulip Revolution in 2005. He fled to Moscow where he returned to teaching physics; he seems to be happier. His country was less lucky. Organized crime factions inflitrated the parliament and assassinations of politicians became common. The Tulip Revolution was followed by the Melon Revolution and low level civil war with the Uzbek minority.

By 2004, the Cameco management decided they had enough excitement and spun off the Kumtor Gold mine into a new company called Centerra Gold. Cameco sold all their Centerra shares by 2009 and left the company to fend for itself.

The initial agreement between Cameco and Kyrgyzstan gave Cameco a 66% stake in the Kumtor Gold mine while the government owned 33%. After Centerra IPO, Kyrgyzstan owned 32% of the newly listed company. But that was not enough. Kumtor Gold was too much of a juicy target: the mine represents 10% of Kyrgyz GDP and 21% of the country’s industrial output. Demonstrations in 2012 and 2013 demanded nationalization of the mine. The government contented itself with taking a 50% stake in 2014, threatening to transfer the operating license to someone else if Centerra Gold didn’t acquiesce.

Things soon took a turn for the worse. Parliamentary elections in October 2020 ended in chaos. Widespread reports of fraud led to protests and the parliament building was set on fire. Election commission annulled the results. The president, the prime minister, the speaker of the parliament, mayors of the two largest cities, and the governors of three provinces resigned. In the confusion, opposition deputies cast around looking for a candidate for prime minister and they found one in the local prison. Sadyr Japarov was serving a 11-year sentence for kidnapping a political rival and taking him hostage. It’s not clear who thought it was a good idea to spring Japarov from the clink. Once outside, he used his connections to organized crime to intimidate all rivals and vaulted himself into the presidential post. He didn’t waste much time in grabbing the biggest prize in the country: his government seized the Kumtor Gold mine in May 2021.

As of August 2021, Centerra’s subsidiaries that owned Kumtor Gold declared bankruptcy. The company filed for arbitration with the UN Commission on International Trade Law, an organization as toothless as its name suggests. The chances of recovering anything look pretty grim. Having poured over $3 bn in investments into the mine since its launch, Centerra will end up with nothing.

The history of mining is littered with stories that resemble the pillage of Kumtor Gold. Newmont’s Batu Hijau mine in Indonesia, Ivanhoe Mines’ Oyu Tolgoi mine in Mongolia, Barrick Gold’s Tanzania mines, and Freeport’s Grasberg mine in New Guinea were all shaken down by the local governments. In Chile, a Senate bill recently proposed a 75% royalty on copper production which would effectively seize all profits. The Peruvian president promised to nationalize mining projects during his election campaign. We will see more seizures, tax hikes, and nationalizations as governments around the world are drowning in debt and grabbing for revenues.

In times of rising commodity prices, most investors gravitate towards investing in commodity companies rather than the underlying commodities themselves. The companies, after all, generate profits and dividends while commodities just sit there, right? But time and time again, we have seen those promises of profits and dividends disappear. A mine is easy to nationalize: the original owner can hardly move it elsewhere, and the local labor and managers can usually continue to operate it reasonably well. The mere threat of nationalization will send the mining company scurrying to the negotiating table and agree to any concessions. The temptation to nationalize increases in times of inflation, especially commodity inflation: the miners are seen as benefiting from undeserved good luck and they should be made to share the windfall. No wonder that commodity equities significantly underperform commodities during inflationary periods.

The majority of new mining projects are in so-called emerging countries. Europe, the United States, Canada, and Australia have been thoroughly explored and exploited over the last few hundred years. The mining industry is deploying ever greater percentage of its capital into countries where rule of law, property rights, and free markets remain a dream. The risk profile of commodity stocks is worse than ever. The wise investor will prefer a ton of copper in a bonded warehouse in London to a ton of copper underground in the jungles of Africa, even if a dividend discount calculation may suggest otherwise.