Research Notes

Fears in Global Recovery and Selloff in Equities
What Does It Mean for Mongolia?

Global selloff on US’s Sovereign Debt. S&P’s downgrade of United States’ credit rating to “AA+” from risk free “AAA” has unleashed turmoil across the global financial markets which were volatile enough as it is. The markets have been concerned about the debt problems in some of the EU countries that have been putting pressure on the recovery of the global economy. To some extent the announcement made by the European Central Bank that it is ready to purchase Italian and Spanish bonds in an attempt to stop contagion of the sovereign debt crisis has been positively received by market participants. However, strong negative investors’ sentiment on the back of US credit rating downgrade by S&P has resulted in significant decline of stock markets and commodity prices for the last three days (August 8-10). All major US equities plunged, including S&P 500 Index -6.6%, DJIA-6.3% and Nasdaq Composite Index-5.9%. Asian markets - Shanghai Shenzhen CSI 300 Index, Hang Seng Index and Nikkei Index have declined 2.5%, 5.5% and 2.8%. We view the current panic selling as the crisis of confidence. Although history was made, not much fundamentally changed. S&P revealed nothing new about the US or global economy, in our view. Sovereign debt issues besieging the western economies have been lingering for quite some time. We believe reducing that debt has no immediate solution, but remains critical for long term well being of global economy.

Mongolian economy will maintain its strong growth. Demand for commodities will continue to set pulse of Mongolian economy. Confidence crisis in the West is unlikely to have any immediate effect on Mongolia. We do not believe the current crisis will degenerate into global downturn akin to 2008, which brought fiscal shock to Mongolia.

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Improved Diplomacy and Strategic Cooperation. Mongolian President Tsakhia Elbegdorj and US President Barack Obama made a joint statement to emphasize their bilateral support to promote their common interests of democracy and human rights, security, and economic partnerships. During President Elbegdori’s visit to the US on June 13-17 this year, the US Senate also passed a resolution expressing support between the governments and peoples of Mongolia and the US. The US government has been an active participant to Mongolia’s democratic reforms since 1991. Recently, on June 10-11, four members of the US House of Representatives met with members of the Mongolian Parliament to exchange ideas on ways to strengthen Mongolian democratic institutions and the bilateral relationship between the two nations. To date, 30 members from both sides have participated in exchanges through the House Democracy Partnership. Mongolia has also taken an active role in security issues for the US. Mongolia’s participation in Afghanistan is currently 190 personnel with plans to double to 400. They had also deployed 990 troops for coalition operations in Iraq from 2003 until 2008. Mongolian forces continue to provide peacekeeping roles around the globe. Currently, 3000 personnel have been deployed in UN and NATO peacekeeping missions.

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LSE signs strategic partnership with the Mongolian Government. The London Stock Exchange Group (“LSE”) and the Mongolian State Property Committee (“SPC”) have signed an exclusive Strategic Partnership Agreement to restructure and develop the Mongolian Stock Exchange (“MSE”), according to the joint press release made public yesterday. In our view, this is an important milestone in the development of the Mongolian securities market with long term positive impact.  According to the agreement, LSE will appoint a management team to oversee MSE development and privatization, and will provide trading and surveillance infrastructure. The MSE is expected to go through a comprehensive reform and upgrade as LSE plans to be involved from advisory and training on capital markets infrastructure and legislative framework, modernisation of market rules and operations to expansion of tradable asset classes (derivatives and ETFs) and introduction of “international standard Mongolian market index”.

Mongolia as the new source for global REE (rare earth elements). China controlling nearly 95% of rare earth minerals production globally and the possibility of demand exceeding supply in the short to medium term provides a strong incentive for Japanese, US and European investment in Mongolia rare earth mining and the associated export infrastructure links. The Japanese and Mongolian governments recently announced their intention to jointly explore Mongolia’s large deposits of rare earths. The Japanese government has also set up a US$150 million fund to search for REE substitutes and to be used to help set up ventures to secure supplies from the US, Canada, Australia and Mongolia.

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Hong Kong the “obvious” choice. Kazakhstan-focused companies are joining their international peers in seeking share offering in Hong Kong. In our view, this development is natural given the recent trend in Kazakh-China relations. The geographic proximity, strategic partnership and economic potential of the two nations offer win-win opportunities for both sides. Kazakhstan is rich in mineral resources and China desperately needs them to secure supply for domestic consumption. Kazakhstan-focused resource companies are seeking alternative sources of capital to finance their projects after losing faith in the traditional western markets, while China has tremendous cash reserves and is in search of ways to better diversify it. Therefore, China is in a strong position to increase exposure to the Central Asia’s largest economy and it is in Kazakhstan’s best interest to have Asia’s largest economy as a partner, especially in the current period of financial system turmoil in advanced western economies. The South China Morning Post quoted Kazakhstan Prime Minister Karim Masimov on October 16 as saying, “Hong Kong is the obvious destination for Kazakhstan, because most of our export products go to China”.

MonBiz Mongolia Index A Debut Global Benchmark for Mongolia-focused Stocks

A Debut Global Index. Earlier this month Eurasia Capital launched MonBiz Mongolia Index, a debut global benchmark that tracks the share price performance of 20 largest companies with assets and operations in Mongolia. The MonBiz Mongolia Index covers publicly listed companies with the total market capitalization of US$15.4bn, including six companies from the Mongolia Stock Exchange and 14 companies from the New York, Hong Kong, Toronto, London and Australia Stock Exchanges. At least one-third of the market value of these companies is related to Mongolia. The Index, which is US$-denominated and market capitalization-based, is aimed to become a leading benchmark for assessing the performance of Mongolia-focused companies.

One of the best performing benchmarks globally. The MonBiz Mongolia Index is up 30.6% YTD and is one of the best performing benchmarks globally. To date it has outperformed MSCI World (-3.31%), MSCI Emerging Markets (-0.40%), MSCI Frontier Markets (1.15%) and vast majority of singly country indices. We believe such outperformance of Mongolian companies is to continue in coming years thanks to the development of the country’s massive mineral resources, improving fundamentals and revaluation of various asset classes in Mongolia.

The Index to expand in value and number of members. Mongolia is the world’s most successful frontier market in terms of companies raising substantial equity capital in various international stock exchanges on the back of resource assets in this mineral-rich country. To date 14 international listed companies that are the members of the Index have already generated US$15bn in shareholder value, which is 2.6 times greater than Mongolia’s total GDP in 2009, the world’s highest ratio for a single country. We believe the index is to expand significantly in value and number of members with a wave of Mongolia resource IPOs hitting various international stock exchanges in coming years (including overseas listings of Mongolian state-owned enterprises). We expect the MonBiz Mongolia Index to be an effective proxy for the rapidly growing Mongolian economy and to serve as a benchmark for global portfolio investors seeking exposure to this exciting frontier market.

IPO Wave is Coming! Earlier this year, the Hong Kong Stock Exchange (HKEx) has witnessed the first full-fledged IPO of a Mongolia-focused resource company. SouthGobi Resources, a Mongolian coal miner raised over US$460mn on the HKEx in January 2010. Last week Reuters reported that Energy Resources, another Mongolian coal miner plans to launch its IPO in Hong Kong later this year. We expect that at least a dozen of Mongolian resource companies and conglomerates to raise capital in Hong Kong in the next three years.

Hong Kong is “a natural choice” for Mongolian IPOs. “Hong Kong is a natural choice in terms of funding and expertise for Mongolia”, Sukhbaatar Batbold, Prime Minister of Mongolia stated in April this year in Hong Kong. In our view, a number of positive factors such as Mongolia’s strategic proximity to China, strong interest from HK and Asia-based investors, Mongolia and Hong Kong being in the same time zone and growing Mongolia-focused peer group at the HKEx provides Hong Kong with a competitive advantage over its global rivals like London and Toronto to lure Mongolian resource companies to Asia’s largest stock exchange, ex-Japan.

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