Modelling Political Risk

One of the dimensions that cannot be easily modeled when assessing investments in emerging junior gold producers is political risk.

As a rule, I generally don’t invest in emerging junior gold producers with its mine(s) in countries with acute political risk.Unfortunately, political risk is a necessarily subjective concept and sometimes controversial.

One of the quick shorthand quantitative sources I use to evaluate political risk in a country is provided by Transparency International's 2007 Corruption Perceptions Index (TICPI).

The index is standardized on a scale of 1 through 10, with 10 representing less corruption and 1 representing more corruption.

Countries with mining operations of interest to me on the TI CPI include:

Sweden—9.3 (Rank tied for #4)
Canada—8.7 (Rank tied for #9)
Australia—8.6 (Rank #11)
U.K.—8.4 (Rank tied for #12)
USA—7.2 (Rank #20)
Spain—6.7 (Rank tied for #25)
South Africa—5.1 (Rank tied for #43)
Romania—3.7 (Rank tied for #69)
Brazil—3.5 (Rank tied for #72)
China—3.5 (Rank tied for #72)
Mexico—3.5 (Rank tied for #72)
Tanzania—3.2 (Rank tied for #94)
Ecuador—2.1 (Rank tied for #150)
Kazakhstan—2.1 (Rank tied for #150)
Venezuela—2.0 (Rank tied for #162)

Another important quick shorthand source I use to evaluate political risk in a country is provided by the Fraser Institute Policy Index that measures the relative “mining friendliness” of 68 political jurisdictions. The most recent version is included in the Survey of Mining Companies 2007-2008.

Leading the Fraser Institute listof mining friendly jurisdictions are the top 10 states, provinces, and countries are:

(1) Quebec
(2) Nevada
(3) Finland
(4) Alberta
(5) Manitoba
(6) Chile
(7) Utah
(8) Wyoming
(9) Ireland
(10) Sweden

The bottom 10 jurisdictions according to the Fraser Institute Policy Index are:

(68) Honduras
(67) Zimbabwe
(66) Ecuador
(65) Panama
(64) Bolivia
(63) India
(62) Indonesia
(61) Mongolia
(60) Philippines
(59) Venezuela

There are four companies that have been hit hard by the market due to unfavorable government decisions. These are cases in support of my “political risk” rule of not investing in corrupt or mining unfriendly political jurisdictions.

Aurelian Resources recently dropped from $10 to about $3 per share after Ecuador decided to freeze exploration and revoke mining concessions.

Crystallex International’s stock price has declined from just over $5 per share to about $1 per share since Venezuela has blocked open pit mining. In late April 2008, Crystallex dropped from about $1.60 to about $0.95 as Venezuela denied previously granted mining concessions.

Venezuela has done this type of action before with Gold Reserves, dropping the share price from $6 to $2 after rescinding a permit in March 2007.

Gabriel Resources dropped from about $5 per share in the summer 2007 to about 3.50 in September 2007. In September 2007, Gabriel Resources dropped even further to $1.50 per share after Romania’s government rejected its environmental impact assessment.

Mining companies with operations in Canada (especially Quebec) and Sweden are likely to be treated in a way that is friendly to investors.

Countries like Brazil and Mexico are somewhat higher risk than Canada or Sweden for investors in emerging junior gold producers. But, these two countries have a track record over the past few years of being more friendly than most countries to mining interests as a way to provide jobs to their citizens and create wealth for their nations.

Clearly, it is best to avoid companies in countries like Venezuela, Ecuador, and Romania if political risk is an important part of your investing calculation.

Best,

Gold Stock Strategist