By Stansberry Churchouse Research. Originally published at ValueWalk.
In 1995, I found myself living in the middle of nowhere.
I was in a country not many people have ever heard of… and even fewer can pronounce – Kyrgyzstan.
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Kyrgyzstan is a country in Central Asia lodged between Kazakhstan, Uzbekistan, Tajikistan and China, as the map below shows.
Back then, just 4.5 million people lived in the country. And its gross domestic product (GDP) was around US$1.5 billion. The country had no stock market (that’s why I was there… see below).
Back then, there were just a handful of international flights out of the country. Making an international phone call was a lengthy process that involved telling an operator what number you wanted to call, and then waiting for him to call you back… meanwhile, with the Internet having just arrived in the country, sending and receiving e-mail was a let’s-make-an-evening-of-it challenge.
Kyrgyzstan was an emerging market in every sense. And one of the first things anyone who has spent time in emerging markets will tell you is how much – and how quickly – these markets can change. Streets that you could cross without looking either way a few years earlier become choked with cars. Buildings, roads, stores and entire cities can appear in a matter of years as the economy ramps up and investment flows in.
But that’s not what we’ve seen happen in Kyrgyzstan.
When I went back to Bishkek
A few years ago, I went back to Bishkek, the capital of Kyrgyzstan, for the first time in 10 years. I saw more cars on the roads… some grocery stores … and a handful of high-end shops. But in many ways, the country is a time capsule of the way it was in 1995.
The winds of change haven’t done much more than blow around a few leaves there.
Kyrgyzstan’s volatile – and corrupt – political environment has scared away investment and stalled growth.
Just 5.6 million people live in Kyrgyzstan today. The country’s GDP is around US$6.5 billion. And the average total daily trading volume on the country’s stock exchange was around just US$63,000.
In short, Kyrgyzstan doesn’t exist to most of the rest of the world. I don’t know if there’s another market that’s further off the radar of investors.
So why have things unfolded like this over the past 20 years? In short, a major reason is widespread government corruption.
How a government kills its golden goose
According to Transparency International’s Corruption Perceptions Index, corruption is worse in Kyrgyzstan than in countries like Nigeria and Ukraine… and the families of Kyrgyzstan’s presidents, in particular, are well-known for abusing their connections.
Things became so bad that in 2005, the country’s president was kicked out in a bloody coup. Five years later, his successor was booted out in a similar fashion after protests against corruption erupted.
The government is also fond of expropriation – taking privately owned property and using it for the benefit of the public.
One of the best ways to see the impact of Kyrgyzstan’s corruption and expropriation is to look at the ongoing troubles of Canadian-based gold producer Centerra Gold.
One of the few things Kyrgyzstan has going for it is that it has some gold. The country is not a natural trade hub, it doesn’t offer a large consumer market, and it’s not rich in natural resources like oil and gas. But it does have the Kumtor gold mine.
Kumtor is Kyrgyzstan’s largest gold mine. In 2016, it produced around 600,000 ounces of gold. That’s not much… it’s less than 10 percent of the annual gold production of Barrick Gold, one of the world’s largest gold producers.
But in the context of Kyrgyzstan, Kumtor is huge. Depending on the year and the mine’s production, it can make up about 10 percent of Kyrgyzstan’s total GDP.
Centerra, a relatively small producer with a US$2 billion market cap, is the controlling stakeholder of Kumtor.
Now here’s where the problems start: The Kyrgyz government owns a stake in Kumtor and a one-third stake in Centerra. And it has repeatedly treated Centerra like an ATM.
Instead of working with Centerra to maximize everyone’s returns on Kumtor, the Kyrgyz government has hit Centerra with every kind of fine and punishment it has been able to think of to extract as much cash from the company as it can.
In December 2012, for example, the government demanded the company pay US$152 million in fines for supposed environmental damage relating to waste dumps, the use of water resources, and other charges. Three months later, the government claimed the company owed it another US$315 million for additional environmental damage. Put together, these excessive charges amounted to nearly half of Centerra’s annual revenues at the time.
For the past few years, Centerra Gold and the Kyrgyz government have been involved in an extended negotiation – more like a protracted barroom brawl – over the ownership of Centerra and Kumtor. The Kyrgyz government wants more shares… and Centerra Gold doesn’t want to cave into the government’s demands.
Kyrgyzstan’s government has routinely said that the country is considering nationalizing Kumtor – which would essentially take ownership of the mine away from Centerra.
In return, Centerra has threatened to shut down operations.
But things heated up in May 2016 when the Kyrgyz government charged Centerra with more than US$100 million in fines for alleged environmental violations.
Centerra disputed the charges and took the case to international arbitration in Sweden.
Then in June 2016, the government added an additional environmental fee of US$220 million. And a Kyrgyz court put financial restrictions on the company – including prohibiting the Centerra subsidiary the operates the Kumtor mine from transferring property or assets, declaring or paying dividends or making loans to Centerra. This led to Centerra suspending its dividend in December for the first time since 2010.
That same month, the government also launched a criminal probe into several of Centerra’s employees – and barred them from leaving the country.
The dispute is ongoing, but last month Centerra got some breathing space when the arbitrator ordered the Kyrgyz government to give 30 days’ notice before resuming its claims. It also announced that Centerra had made a case for the arbitrator to take jurisdiction over arbitration proceedings, and had been convincing regarding the merits of the case. (But, whatever the eventual outcome, there’s no guarantee that it will be recognised or enforced by the Kyrgyz government.)
The political shenanigans around Kumtor have been the reason for the volatility in Centerra’s share price.
And these have been just a few of the trials and tribulations faced by Centerra Gold and its shareholders in recent years.
Yet, each year, the government has extended permits to allow Centerra to mine at the site for the next year. So in December, the company received its permits and approvals to operate the mine through 2017.
You see, one thing investors forget is that the Kyrgyz government needs Centerra.
“The government has little interest in nationalizing the project and is unlikely to remove Centerra as the
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