Summary
- Mongolian parliament approves the resolution regarding the current investment agreements for Oyu Tolgoi.

- The country wants either a product sharing agreement or a royalty.

- Shares react positively, getting an additional boost from rising copper prices. The short-term upside price momentum looks interesting.

In my recent article on Turquoise Hill (TRQ), I wrote that the most likely pattern for Turquoise Hill shares was to trade at a $0.40-0.50 range until the end of this year amidst uncertainty regarding the potential new terms of the investment agreement for Oyu Tolgoi. This prediction did not work out well, since the stock broke out of the trading range on higher trading volume and is trending higher:

From a technical point of view, that’s a major breakout that no momentum trader will miss. But what’s on the fundamental side of the story?

The Mongolian parliament has just approved the resolution that instructs the government to look at the ways to improve the implementation of the investment agreements, the underground mine plan development and the financing plan of the mine. In the press release to which I linked above, Rio Tinto (RIO) stated the following:

Rio Tinto acknowledges the Mongolian parliament’s resolution and notes that this effectively confirms the validity of all Oyu Tolgoi investment agreements […] There is a lot of work to do to ensure Oyu Tolgoi reaches its full potential, and we remain committed to exploring ways to deliver even greater benefits from Oyu Tolgoi to all shareholders.”

Turquoise Hill went into more depth in its press release, outlining the measures included in the resolution: 1) comprehensive measures to improve the implementation of investment agreements; 2) improvement of the mine development and financing plan and 3) decision to “explore and resolve options to have a product sharing arrangement or swap Mongolia’s equity holding of 34% for a special royalty.”

Here are the key practical conclusions as I see them:

Certainty is almost always better than uncertainty for the market. The Oyu Tolgoi story is somewhat similar to Freeport-McMoRan’s (FCX) Grasberg mine, which also struggled from the growing appetite of the Indonesian government. The removal of Indonesian uncertainty was certainly a positive catalyst for Freeport. While Oyu Tolgoi does not have this level of certainty yet (Grasberg ultimately got a final (hopefully) deal), the fact that the resolution did not contain anything truly critical for business is surely a positive catalyst for Turquoise Hill.
It’s still too early to talk about how a product sharing agreement or a swap of current Mongolia’s stake for a special royalty might look like. For reference, Freeport’s deal for Grasberg included a 25% corporate income tax rate, a 10% profits tax rate, 4% royalties for copper and 3.75% royalties for gold.
I believe that the royalty scenario will be strategically better for Turquoise Hill compared to the product sharing arrangement. Once Mongolia swaps its current stake in the project for a pre-defined royalty, it will be easier for Turquoise Hill and Rio Tinto to defend against any additional claims from future governments (the current trend in this space is unfavorable for international mining companies, and there’s no reason to believe that this negative trend will stop in the coming years).
We currently see a relief rally in Turquoise Hill shares. In such situations, fears of the worst outcome are always somewhere in the background even if no one voices them publicly – such fears are removed for now. Also, we should not forget about recent copper price upside which could have provided some additional support to building momentum trade in the company’s stock. At this point, the short-term trend has certainly changed to the upside.
There are still many variables in the Oyu Tolgoi story: the exact changes to the investment agreement are yet to be determined, while the new operating and financing plans for the mine will be known only in 2020. Therefore, the stock comes with a material headline risk which can bring both major upside and downside.
At this point, it looks like the news from Mongolia and copper price upside created a short-term setup for upside in Turquoise Hill shares. Fundamentally, the story remains promising (as always) but risky, so size your positions accordingly and manage your risks properly if you want to join the momentum trade.

By:Vladimir Zernov

Published Date:2019-12-13