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By John Helmer in Moscow

In the world of mining, it can be much more profitable to leave the gold in the ground, and take out the cash from booming share or equity value. According to Oleg Mitvol, the mine regulator for the Russian Ministry of Natural Resources until last month, Russian goldminers are guilty of investing in only one kind of digging — on the stock exchanges, where share prices are driven by gold reserves in the ground.

The paradox of Russian gold equity value starts with this: in terms of gold reserves, Russia ranks second in the world, trailing only South Africa. However, in terms of gold production, Russia is currently lagging in sixth or seventh place – behind China, South Africa, Australia, the US, Peru, and sometimes Indonesia.

For stock market hustlers, this discrepancy is treated as a positive – a disproportionately low production level relative to the resource base, suggests significant upside or growth potential. If a global or emerging market investment strategy recommends the gold sector for all the reasons that make the precious metal attractive in current conditions, then this anomaly, the reserve potential factor, should recommend Russian goldmining stocks for buying.

That is, unless investors suspect that Russian reserve potential is a mirage, a pig in a poke, or worse, a fake — that there’s a relatively high Russian risk that the local miners will delay the capital expenditure required to bring their new projects into production, and fill out their reserve totals by moving paper, instead of shovels.

Just how far and how fast gold equity values can move can be seen in China, where two of the leading goldminers listed on the stock exchanges are Zijin Mining Group, with a current market capitalization equivalent to $3 billion; and Zhongjin Gold Corporation, worth roughly the same.

In market value, they are less than half the value of Polyus Gold, Russia’s leading goldminer, whose market capitalization is currently about $8 billion. But each of the Chinese miners is substantially larger than the value of the second largest Russian goldminer, Polymetal, currently at $2 billion; or the next two Russian goldminers, Peter Hambro Mining and Highland Gold, at $1.7 billion and $241 million, respectively. Even allowing for Peter Hambro’s recent capital gain from absorbing its Aricom non-gold affiliate, the two Chinese goldminers are one and a half times the value of the three Russians.

Also, the remarkable difference between the Chinese and the Russians is that Zijin and Zhongjin have shown earlier and faster recovery of their share price, following last year’s crash, compared to their Russian rivals. Also, their shares show relatively greater price stability — they have managed to strike new share-price highs every month for the past six, despite the downturn of the bullion price since mid-February. So strong is the surge in this share value, Zijin was obliged to issue a cautionary to the Shanghai stock market a month ago, saying it had no information to explain the takeoff in the company’s share price. “”There is no planned major asset sale, private placement or other matters involving the company in the next three months that may have significant impact on its share price,” the company announced.

The Russian goldminers also report a share price recovery over the past three months, but it hasn’t lasted. They appear to have hit peak, and have begun haemorrhaging value for a month or more.
If goldmines are money factories, as investors like to think, then the colour of the money should be the same — China’s gold cannot be more gilded than Russian. Nonetheless, the Chinese miners’ share prices sparkle more brightly.

That’s because there are nagging doubts in the marketplace that the value of current Russian gold reserves is as good as the miners like to claim. And the reason for that is that the largest unmined Russian deposits – Natalka and Nezhdaninskoye (both owned by Polyus); and Sukhoi Log (held by the state, unlicensed to date) – will not be developed in the foreseeable future. Without them, the future of Russian goldmining cannot glister like the China’s goldmining future.

Late last month in Moscow, a senior official at the mine licensing agency, Rosnedra, announced that the government is postponing the auction for the licence to mine Sukhoi Log for at least another year. The reason is plain — none of Russia’s goldminers wants to commit its cash or borrowing capacity to bid, and then to build the $2 billion mine. Licensing requirements Rosnedra supervises to ensure production and investment targets are met at Natalka, Nezhdaninskoye, and elsewhere have all been relaxed or postponed.

Last week, Highland Gold, a London-listed goldminer controlled by Roman Abramovich, announced it has sold off its Mayskoye mining project for $105 million; the giveaway price is half the book value of the deposit, whose gold reserves have been estimated at up to 7.5 million ounces, making it the largest stock of value in the Highland’s asset portfolio. At the time in 2003, when Highland bought Mayskoye from Abramovich, then governor of the region where the project is located, the company told the London stock market “the acquisition of Mayskoye is a transforming transaction for the Group. We are acquiring a world class, long life, low cost deposit in a transaction which doubles the Group’s resource base.”

Polymetal has now taken the asset off Highland Gold’s hands on terms which led a Moscow gold analyst to conclude “this low price also includes the many operational risks related to the development of the Mayskoe deposit. For example, after a thorough review of the project Highland Gold decided to sell the license rather than face these risks.” The investment market decided the risks were destructive of both companies’ stock value, and cut Highland’s share price by 22% on the first day; Polymetal’s by 1%. This week, following the May Day holidays, Highland is down 10%, Polymetal down 2%.

Polyus Gold hasn’t been selling off its large-reserve assets. It has simply announced that it intends not to spend a penny bringing them into production for the foreseeable future. The Natalka deposit in Magadan, for example (also known by the licensee’s name, Matrosov), accounts for two-thirds of the Polyus asset portfolio. But acknowledging that the development of the first phase of the mine will cost the company $1.1 billion, and annual production will not reach a million ounces before 2017, the management has said it is consigning the project to feasibility studies and state-funded infrastructure construction for the time being.

Just how short-term Polyus Gold intends to be was signaled by the buyout in March and April of founding shareholder Vladimir Potanin by Suleiman Kerimov, a well-known Moscow arbitrageur, if that’s the correct term for what he is. Although he has occupied two Russian parliamentary seats, one in the State Duma and one in the Federation Council, Kerimov never answers questions in public about what he does, thinks, or intends to do. The only public demonstration of his capabilities was a driving accident on the main street of Nice in November 2006, with considerable personal cost and suffering. Much more profitable, but altogether private, was Kerimov’s purchase of 100% of Polymetal for $930 million in January 2006, most of it borrowed from the state savings bank, Sberbank; and his subsequent sale of a 68% stake in mid-2008, at an estimated at $2.1 billion.

It is also known about Kerimov that over the past eight weeks he paid Potanin in two tranches about $1.3 billion for a 37% stake in Polyus. The stake is close to that of shareholder Mikhail Prokhorov, but is viewed by Prokhorov as no threat to his control of the company. Such an arrangement is unprecedented in Russian stockholding practice, and has raised questions about whether Prokhorov may be one of the sources of Kerimov’s financing for the deal. Potanin’s price has been estimated to have been at a 60% discount to market at the time.

The Russian investment banks rushed to congratulate Polyus Gold on achieving an end to the bitter shareholding fight between Potanin and Prokhorov; in the course of that, Potanin and Polyus’ independent directors had made public allegations and some evidence of asset-stripping, feather-bedding, and other value-destructive conduct. There has been no subsequent assessment of whether Kerimov is likely to have a different impact, particularly on the non-Russian minority shareholders most aggrieved by the Russian infighting.

By abandoning two of the largest unmined gold deposits in the country, Sukhoi Log and Mayskoye, Abramovich and the Kremlin have decided to let Russia’s goldminers apply their shovels to the stock markets for the foreseeable future. And that’s pretty much what Kerimov and Prokhorov appear to want, too.

That is also the meaning of a complaint filed in March by Russian shareholders, who have taken Polyus Gold to the London Stock Exchange regulator, the Financial Services Authority (FSA). The Moscow-based holding, Westway Alliance Corporation, with an 8% shareholding in the Irkutsk region goldminer Lenzoloto (“Lena [River] Gold”), and a smaller stake in Polyus Gold, alleges asset stripping and share value dilution, along with the charge that a fair hearing of the claims is impossible in the Russian courts. At the heart of the complaint filing is the sale of shares at what is alleged to have been ten times less than their fair value, and the valuation of gold reserves transferred at many multiples below the book value. The gold in question includes part of the Sukhoi Log deposit. Lenzoloto, it is alleged, has been the loser, Polyus Gold the gainer, in transactions that were not fully disclosed or properly valued in Polyus’ listing prospectus, nor in the company’s ongoing financial reports. Polyus is saying it has not been contacted by the FSA and seen no sign of the London case.

There is no telling how complaints like this will end up with the UK regulator, for the FSA isn’t obligated to say what it will do with a file, or whether it will do anything at all. Still, the prevailing market sentiment indicates a level of suspicion about the risk of Russian goldmining companies that is discounting Russian gold equities and holding them down, compared to their peers.

And that’s where the large South African goldminers might be enjoying a taste of revenge. For Harmony Gold, Anglogold Ashanti, and Gold Fields have all ventured into the Russian mining sector, only to be pushed away. JCI and Standard Bank were the first investors in the licence to mine Sukhoi Log, before it was arbitrarily revoked in 1997 and the foreign investment lost. Harmony Gold made its Russian debut in 2002 as a founding stakeholder in Highland Gold, only to bail out during a raid on Highland’s principal mining licence. AngloGold tangled with Polyus Gold over the development rights to its deposits in the Sakha republic of eastern Siberia — and lost. Gold Fields was the target of a scheme by Potanin and Prokhorov to take over its offshore gold assets and create a new company.

In retospect, the South Africans can count the cash profit of their close encounters with the Russians.
There is more than irony, too, in calculating what the South Africans might have lost, but didn’t — and what they may yet be invited to pick up on the cheap. The collapse of Highland Gold has led Marat Gabitov, precious metals analyst at Unicredit Securities in Moscow, to urge the sale of Highland to a real mining company. “Given the poor track record of the [Abramovich] company,” he says in a note to clients, “we believe that best value-creation option for HGM now could be sale of the company for shares to a team of industry professionals, gaining from the premium that may potentially be offered and assurance of timely fulfilment of development plans of the company.”

Of course, when it comes to calculating the NPV for timely potential, Chinese gold has an allure that Russia cannot compete with. Not now. Not yet.

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