Mongolia Will Play An Increasing Role Connecting China And Russia, And Asia To Europe.

September performance for the Khan Mongolia Equity Fund (KMEF) was -7.28%. Following two months of double-digit positive performance, the portfolio was negatively impacted over the month by a sell-off of international listed mining juniors within the portfolio, largely in line with the mining and resource sector. The fund remains +10.00% year to date.

Mongolia Update

Although September passed without full resolution of outstanding issues between the Government of Mongolia (GOM) and Rio Tinto (Rio) regarding the second phase development of the world renowned Oyu Tolgoi (OT) project, several sources close to the negotiations have informed us that they are confident the project will be signed off before year end. The European Bank for Reconstruction and Development said it has already granted an extension for its financing commitment, and we believe that most, if not all, of the 15 lenders within the financing syndicate for the USD 5.4 billion Phase Two expansion will follow suit.

The impact that this investment will have on Mongolia’s USD 11.5 billion economy cannot be understated. The multiplier effect through OT’s supply chain to the economy at large represents a massive boost to economic activity and will ultimately drive additional investment into key infrastructure development.

Mongolia’s Fall Parliament Session started on October 1 with an immediate action plan to decrease the number of Ministries from 16 to 13. Several ministries are being restructured to create greater efficiency by alleviating duplication of responsibilities and reducing bureaucracy. We see this maneuvering by the Prime Minister as a positive step towards creating clarity and consistency of responsibilities and perceive the reorganization as positive; providing economic savings, increased transparency and decreased bureaucracy.

Following the recent amendments to the Mining Law, regulations on issuing new mining exploration licenses have now been clarified. A new system that will use state of the art technology to receive applications and issue licenses has been adopted in order to improve efficiency and provide transparency. Although initially delayed due to technical issues, it is expected that new licenses will begin to be issued before month end. As previously noted, the “best in class” amendments to the Mining Law (including extension of exploration licenses to 12 years) coupled with last year’s progressive Investment Law, now make Mongolia one of the most attractive destinations for mineral exploration in the world. The mineral exploration and extraction sector clearly remains one of the key drivers of Mongolian growth. The opportunity to undertake new exploration within the resource rich country is bound to deliver some impressive results including the possible discovery of further mega-deposits such as OT and Tavan Tolgoi.

Sub-custody services are now being introduced by Mongolia’s two largest banks, Golomt Bank and Trade & Development Bank (TDB). The system is in the process of testing and is expected to be offered to investors by year end. International investors will soon be able to freely trade securities on the Mongolian Stock Exchange (MSE), which recently extended their partnership with the London Stock Exchange for a further 3 years, using their global custodian via sub-custody and clearing with either Golomt or TDB. We strongly believe that this opening up of Mongolia’s capital market will drive investment and liquidity into the nascent exchange where many companies continue to trade at low price-earnings and price-book ratios when compared to their emerging market peers.

A further indicator of strengthening bilateral ties, Russia and China have announced that the two countries are considering building a high-speed rail line thousands of kilometres from Moscow to Beijing. According to the Beijing Times, the project would cost more than USD 230 billion and be over 7,000 kilometres long. The proposed rail line will traverse Mongolia and will apparently cut the journey time from six days to two. Furthermore, Mongolia and Russia have officially agreed to cooperate to construct a highway that would connect Russia and China through Mongolian territory. The memorandum of cooperation was reached at the 18th meeting of Mongolia-Russia intergovernmental commission (13 – 15 October), which was focused on bilateral trade and economic cooperation. The highway is expected to run from Mongolia’s northern border district of Altanbulag through the capital of Ulan Bator to the country’s southern border town of Zamyn-Uud. The projects are expected to drive further foreign direct investment (FDI) and boost infrastructure construction throughout the country.

KMEF Portfolio Update

Mongolian Mining Corporation (976:HK – “MMC”) rallied 42.62% from the beginning of September to close the month at HKD 0.87. Turquoise Hill Resources Limited (TRQ:US) gained 11.24% to USD 3.76 on expectations of OT progress, although has now fallen to early September lows. Xanadu Mines Ltd (XAM:AU) was sold off 21.88% to AUD 0.125 and Kincora Copper Ltd (KCC:CN) lost 33% from CAD 0.06 to CAD 0.04.

Given MMC’s recent price performance, now up 90% from lows of HKD 0.48 in June, we expect MMC to potentially consider a rights issue, which we believe many shareholders would participate in. This would clearly have a positive impact on the company’s 8.875%, MAR’17 bond which last traded at USD 62.54 and has a current yield-to-maturity of just over 30%.

Company News

Erdene Resource Development Corp (ERD:CN) announced last week that it plans to raise CAD 1.61 million by way of a non-brokered private placement in order for the Company to carry out a resource drilling program on its 100% owned, highly prospective Altan Nar gold project. The objective is to establish an initial, independently verified, near surface, open pit mineable resource estimate by March 2015. The placement is expected to close on or before October 31, 2014. The KMEF is invested in ERD and participated in the Company’s last two private placements (NOV’13 – CAD 0.07, MAY’14 – CAD 0.16). The KMEF will participate in the Company’s recently announced (OCT’14) private placement at CAD 0.14. Erdene’s President and CEO, Mr Peter Akerley, recently visited Singapore and Hong Kong to meet with prospective investors. We are confident that the placement will be fully subscribed and are happy to see the company funded to meet their objectives of delivering an independently verified resource estimate by Q1 2015.

Guildford Coal Limited (GUF:AU) announced that shipment of the second trial batch of coal (14,300t) from the Baruun Noyon Uul (BNU) has commenced. Testing of this batch of coal is due to be completed by month end and the company expects that testing will confirm even more favourable results than the first trial batch as coal has been taken direct from the mine rather than the long term mine stockpile. Guildford is intending to ramp up production in the coming months, with preparation for mining to be conducted throughout November and full-scale production targeted in early 2015. Production is expected to be cash flow positive in 2015, with a targeted margin (per ROM tonne) of AUD 9-14, which takes into account the impact of the recent announcement by the Chinese Government re-instating coal import tax of 3% on coking coal imports. We continue to believe that the fundamentals that make Mongolia a natural coking coal supplier to China remain the same.

Khan Secures AUD 13.6M financing for Xanadu Mines Ltd.

Khan Investment Management Ltd. (Khan) is pleased to announce that it, together with its partner Asia Capital & Advisors Pte. Ltd., has secured funding commitments for Xanadu Mines Ltd. (XAM:AU – “Xanadu”) of AUD13.6 Million (USD 12 Million) by way of a private placement. Whilst the placement is subject to shareholder approval at the company’s annual general meeting, we are pleased to have been able to raise significant funding commitments for Xanadu to potentially be in a position to advance its highly prospective copper-gold “Kharmagtai” project.

The amount of this funding is sizeable in the context of current market conditions and shows Khan’s continued commitment to investing in Mongolia.

Concluding Comments

Whilst the international media was quick to criticize another missed deadline for OT, it is clearly in the interests of both the GOM and Rio to resolve outstanding issues and proceed with the USD 5.4 billion Phase Two development as soon as possible. Based on our discussions with sources involved in the ongoing negotiations we remain very confident of a green light before year end, which we believe will act as the most significant catalyst for a revaluation of Mongolian assets across the board and drive the next wave of FDI into the country.

The strong fundamentals underpinning Mongolian growth that we and others have so often pointed out remain firmly in place. Mongolia’s resources will not disappear. Mongolia will remain the neighbour of China – already the world’s second largest economy. Mongolia will play an increasing role connecting China and Russia, and Asia to Europe.

The most common cause of low prices is pessimism – sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces.” -Warren Buffett

I thank our investors for their continued support and I look forward to updating you further next month.

 

Best regards,

Travis Hamilton
Chairman
KHAN INVESTMENT MANAGEMENT LIMITED