Chapter 11
Other Places, Other Opportunities: Mongolia, Argentina, Russia, Turkey, and Central Asia
We're coming close to the end of our globe-trotting investment field trip. There are many more markets and many more opportunities we won't be able to visit this time around. They will have to wait. Nevertheless, there are a few more markets that I want to tell you about before we make our way back home.
Let's start in the “Land of the Blue Sky.”
The story of Mongolia's resurgence is mouthwatering for investors for one reason. Mongolia is rich in natural resources, and it sits next to the world's most voracious consumer of those resources, China.
Beneath Mongolia's rugged mountains and slumbering sands lie huge untapped resources of copper, coal, gold, uranium, iron ore, oil, and more, only recently discovered. In 2010, this country exported about $2 billion worth of minerals. But based on mining project startups, exports ought to grow to $20–80 billion per year. That's a 10- to 40-fold increase in just a couple of years. Some $30–50 billion in new investments are set to flow to this economy in the next few years.
But there is a long way to go. Production of coal, iron ore, and crude oil should rise ten fold over the next 10 years. The 10 largest deposits are worth over $1.3 trillion. For perspective, Mongolia has a $4.5 billion economy. (Yes, billion.)
Oyu Tolgoi is one of those big deposits. It is the world's largest new copper and gold mine, with some 80 billion pounds of copper and 46 million ounces of gold. It is a joint venture between Ivanhoe Mines and Rio Tinto. Here is the mind-boggling part: This one mine will represent about 30 percent of Mongolia's economy when it starts producing. Just one mine.
Another big one is Tavan Tolgoi, which is in what may be the largest undeveloped coking coal district in the world, with more than 6 billion tonnes of coal. These are staggering piles of wealth for a nation of only 3 million people. Some believe these resources could turn Mongolia into another Qatar or Norway.
Qatar is an example of a country that got rich after exploiting a massive natural resource. In Qatar, it was natural gas. The Qatari stock market went from $4 billion in 1998 to $104 billion by 2010—a 27-fold increase.
Another example is Kazakhstan, as Brad Farquhar, my friend from Saskatchewan, points out. We will hear more from Brad in the next chapter on Canada, in which we'll look at his canola fund and Saskatchwan farmland. In addition, Farquhar has an interest in Mongolia and has been making regular investing field trips there, enthralled by the opportunity he sees there.
“The Kazakhstan stock market went from something like a billion-dollar market cap to $100 billion in eight years,” he writes:
Mongolia, I think, is on a faster growth track with a more diverse resource base. It has better logistics to access markets in China, Eastern Russia, Japan, and Korea than Kazakhstan. Plus, Mongolia is a free and open democracy. For what it's worth, Mongolia's president has photos of Ronald Reagan and Margaret Thatcher on his office wall. In addition, the Mongolian stock market surpassed the $1 billion market cap mark in 2011.
That stock market was the best performing in the world in 2010, up 125 percent. My guess is that it is only the beginning of a long bull market. Eurasia Capital estimates that Mongolia will be the fastest-growing economy in the world over the next decade.
The Mongolian currency, the tugrik, has been among the world's best-performing currencies against the dollar. Farquhar sent me a neat little stack of fresh Mongolian tugriks. It's colorful money. The blue-green five spot features Sükhbaatar, an important figure from Mongolian's struggle for independence in 1921. On the reverse side is a pastoral scene of horses eating grass with mountains in the background.
“I went to Mongolia last summer,” our correspondent continues:
I came home convinced that the country will do incredibly well over the next decade. In order to try it out myself, I opened an account on the Mongolian Stock Exchange in early November, and I have been searching out companies on other global exchanges that have significant Mongolian exposure. In the first four months, my own Mongolia-specific portfolio is up 84 percent, and I have some friends and colleagues clamoring to get in.
So, Farquhar decided to open up his own “super-exclusive Mongolia-focused micro-hedge fund.”
Other opportunities should occur, too, outside of mining. Mongolia will need to double its power output in the next five years at a cost of at least $2 billion. It needs highways and railroads. All that mining will require water. Mongolia has water in deep aquifers beneath its deserts, and there are northern rivers it could divert, but all this, too, costs money. Somebody has put all that together.
In fact, one group is focusing on everything but mining. Mongolia Growth Group is a recently formed company trading on the Pink Sheets. It intends to invest in real estate, industrial, and service companies in Mongolia.
The company had an interesting beginning. It started with Harris Kupperman, who was running a hedge fund. He took a trip to Mongolia in the summer of 2010, poking around for investment ideas. Bowled over by what he found, Kupperman started Mongolia Growth Group and moved to Ulan Bator. “The Mongolian economy is far more robust than I had ever imagined,” he writes. “Unable to find an ideal way to invest in Mongolia, I have instead set out to build my own diversified entity.” He eats his own cooking, too, as Kupperman and his management team own 58 percent of the company.
I caught up with Kupperman by phone. He was in Ulan Bator. I was in Maryland. It was 1 a.m. for him. “Welcome to finance in Mongolia,” Harris told me, a veteran of many wee-hour conversations.
Kupperman reiterates that Mongolia is a place of rich mineral wealth. “Every time someone puts a shovel in the ground, they seem to find something valuable,” Harris said. But Harris isn't playing the commodity boom. The mining companies tend to be fairly valued and well covered. Instead, Harris looks to play trends in real estate and finance, places that ought to prosper as people have more money. This seems a good idea.
In fact, the reason for my call to Harris was a piece in The Wall Street Journal noting how luxury brands such as Louis Vuitton, Burberry, Zegna, Emporio, Armani, and Hugo Boss all have stores in Ulan Bator. Burberry plans a second store in the Shangri-La Hotel, currently under construction. Ferragamo and Dunhill are looking to open stores. This in a place that doesn't even have street names and only recently introduced ZIP codes.
Something big is going on. Harris looked at buying existing Mongolian companies but has since given up. They are impossible to figure out.
He tells some funny anecdotes about meeting with Mongolian companies. One CEO was so happy to see him, he posed for pictures. He had never had investors visit before. Then there was the time he was thrown out of somebody's office for asking for a copy of the financials. Or the time when they gave him their latest figures from 2007. Or the time when the company couldn't even tell him how many shares were outstanding. Or the CEO he met who was most proud of the production awards the plant won in the 1960s under Soviet rule. Or the time he asked a company why he hadn't received the stated dividend. They told him to drive 500 miles to the mine and pick up the check himself.
Nonetheless, Harris bought a basket on the theory that if Mongolia did well, it'd do well. Still, Harris wanted to put more money to work, so he started his own company.
“We're buying about $1 million of property a week,” Harris told me at the time. They are cherry-picking the best assets. On the residential property, you can get double-digit yields, but if you spend a little money to make it look nice, you can get 20 percent yields. And prices are increasing 2 to 3 percent per month. Rental rates have doubled in two years.
Harris told me the story of a $400,000 property sale settled in cash. The seller was a little old lady, about 4′2″ and weighing 95 pounds. Harris arrived with a large brick of money. When the closing was all done, she put the money in a bag and walked out. “I offered to drive her home,” he said, “but she thought that was crazy. It's really very safe here.” I can only imagine that woman tottering out in the street with $400,000 in a shopping bag.
Real estate is probably the most exciting thing MGG is doing. “When another fund comes along to replicate what we're doing, these assets won't be there,” he said. Harris pointed out how small an area downtown was. Harris knows of funds being raised in the hundreds of millions to buy real estate there, and as the money came in, prices had to rise. “The only way for yields to get to 5 percent here, as in the rest of the world, is for prices to triple.”
MGG got its insurance license for its wholly owned insurer, Mandal General Insurance. The first policy underwritten will be Harris' SUV. There is tremendous demand for insurance. MGG was getting calls before they even had their license. Today, Mandal General is a 17-employee operation with $5 million in capital.
The beauty of insurance, as Warren Buffett famously profited from, is its ability to generate “float,” or the upfront cash from the premiums collected. Until claims are paid, this float is MGG's to invest. Harris is a proven investor. His hedge fund is up over twenty fold since its inception in 2003, and I suspect his ability to invest this float is a big cherry atop the MGG financial sundae. “In a market in which structured debt products routinely yield better than 20 percent and where rental properties earn double-digit yields,” Harris writes in his latest shareholder letter, “I am hopeful that we can produce very attractive returns on this float.”
MGG is super shareholder friendly. Harris takes no salary and no stock options. He makes money only if the stock goes up. He put $3.5 million of his own money in MGG and owns 17 percent of the company. His board includes noteworthy investors, such as Bill Fleckenstein (who owns nearly 9 percent of the company).
Next up for MGG? Harris says the company is near profitability. He wants to start paying a regular dividend to show investors what they are doing is real. He aims to list on the Toronto Stock Exchange. “There is a huge secular tail wind under way,” Harris sums up. “This tail wind will go on for decades, and the assets are simply not priced for the upside that we see.”
To sum up: Mongolia has waited a long time for another turn at bat in a big game. In the thirteenth century, Mongolia was the seat of the largest territorial empire the world had ever known. The hordes erupted out of Central Asia, conquered Russia, China, and most of the Middle East. (Only the powerful armies of the Mamluks of Egypt checked the hordes' advance at the Battle of Ain Jalut.) Pax Mongolica reigned until the arrival of the Black Death. As far as the rest of history goes, Mongolia hasn't registered much since.
Thanks to its mineral wealth, it looks like Mongolia will enjoy another turn on the big stage with the eyes of the world watching, and some getting rich, besides.
Argentina: Ruining a Good Thing
“There's an old expression in my family, in every Argentine family,” my guide Maria told us as we zipped down a new freeway heading out of Buenos Aires to a town called Tortugas. “Buy the bricks . . . always buy the bricks.”
In that little nugget lies the key to successful investing in Argentina, or anywhere, for that matter, where holding cash for any significant length of time is problematic.
The Argentines have learned the hard way. In 2002, the peso was on par with the dollar, one for one. Today, that exchange rate is closer to four pesos for $1. Put another way, the peso has lost about 75 percent of its value against the dollar in 10 years.
If you had money in the bank denominated in Argentine pesos, such as a certificate of deposit, a bank account or other paper assets, you lost big.
To preserve wealth in that environment, where the currency is flaming out like a lit match, you needed to own tangible things. “Buy the bricks” refers to buying houses and buildings. When Maria's family got some extra money, they'd put it into a house.
More broadly, though, we can think about it in terms of buying tangible assets: land, precious metals, vineyards, timberlands, oil in the ground, or what have you.
In Tortugas, I met a businessman and investor who had interests in real estate properties and retail operations. He was a partner in a private investment firm. Federico took us to his house, one of the original group built in this development 60 years ago. We had drinks while sitting on his back porch, which looked out on a beautiful garden and pool. Federico was frank in his assessment of Argentina.
“Argentina, the piece of land itself, is a paradise on Earth,” he told me. It is rich in natural resources, plentiful green land, lots of trees and water, a long growing season, and no hurricanes or snowstorms. It seems to have everything. The problem has been the government. Federico said doing business in Argentina is “like spending all day with God, only to have dinner with the devil.”
Argentina was once among the richest countries in the world, and Buenos Aires among its most sophisticated and cosmopolitan cities. As late as the 1920s, its only rival in the Western Hemisphere was New York. There was a large, educated middle class in Buenos Aires. There was the grandeur of its Beaux-Arts architecture. It had the largest opera house and the finest newspapers and universities in Latin America. It has fallen a long way since.
Walking around the city, one can easily imagine how great and wealthy this city once was. There are reminders everywhere: beautiful European-style buildings, broad avenues and plazas, and narrow, cobbled side streets lined with cafes and small shops. It is sad to think of the opportunity wasted. This place should truly be among the richest cities on Earth.
Federico, though, had not yet given up hope. “Argentina is a country of the future,” he said. “There is plenty of opportunity here.”
Later, Federico took us on a helicopter ride over Tortugas, which is only about 20 minutes from Buenos Aires. There is a freeway that connects Buenos Aires with suburban towns like Tortugas. Federico pointed out the large swaths of land and trees in the area. “Imagine what it could be,” he said. He told us of projects in the works or in the planning stages: houses, shopping centers, golf courses, and more.
There is tremendous potential here. It's a developer's dream, with lots of land, water, mature trees, relatively flat country. It is a palette of possibility.
Real estate is cheap. With what it costs to rent an apartment in London, you could buy 10 in Buenos Aires. That's why Americans and Europeans have been among the most active buyers of property in Argentina. They are real estate bubble refugees, you might say. They cashed out of their expensive and inflated properties in the United States and Europe, and then they came down here and lived like kings. The inflated prices deflated, and these people look particularly smart.
The effects are tangible on the streets on Buenos Aires: busy restaurants, packed seaside resorts, and all the usual trappings of prosperity.
When in Argentina, I traveled around rural areas in Salta. I spent some time at a ranch and viewed properties owned by American and European investors seeking to develop them into residential communities, golf courses, vineyards, and more.
There are some 60,000 acres here at this ranch. It has livestock and grows alfalfa, tobacco, and corn. This place was owned by a group of overseas investors who had plans to carve off lots and develop the property while maintaining it as a working ranch.
Besides the potential for development, the agricultural lands out here should grow increasingly valuable. As I've written elsewhere, several factors are fueling a boom in the agricultural markets. Argentina and South America should prosper from these trends. Argentina is one of the great food-producing countries in the world, with cereal, sugar, fruit, wine, tea, and cotton among the crops grown there. Finally, Argentina is a big producer of beef.
This creates opportunities through the back door, like in fertilizers and farm equipment. I couldn't help but notice the ranch's small fleet of John Deere tractors. Basic infrastructure is vital. Water resources are critical for any kind of agricultural concern. Cafayate has plenty of water. The owner of the property proudly told me several times about the abundance of water on the property and his ownership of the rights.
In other places, clean water is a concern. In San Rafael; for example, a region that produces 70 percent of Argentina's wines, as well as olives and other fruit, there was concern over pollution affecting the water and soil.
Politicians can get in the way of the best ideas with wars, stupid policies, taxes, and excessive regulation. And talking to people there, there is a wary sense about how the government will screw it up again. The basic problem with government there, and nearly everywhere, is that there is too much of it.
In Cafayate, which sits in a valley surrounded by rugged, red-speckled mountains, I walked a property owned by investors who have a compelling vision for what could be. It doesn't take a lot of imagination to see how property here would be an attractive place for expats to buy a second home, a place to escape the cold winter months, or just as a place to come recharge your batteries and get away from it all.
Cafayate is wine country. The weather is pleasant with 320 days of sunshine a year. There is plenty of water. We visited a vineyard and plucked juicy, flavorful grapes right off the vine. I'd never tasted grapes with so much flavor.
Development is still in the early stages. Ultimately, Cafayate will have a golf course, hotels, and more to cater to a growing stream of tourists and snowbirds. They will live well for little money. One night, we had a dinner party of eight. We drank wine and ate appetizers and steak. The bill was almost laughably low, about $70. Later, we had six beers and coffee for a total of $7.
The next day, we met with some gauchos and rode horses through the lush ranch in Salta.
The gauchos are some tough hombres and good with horses, as you might expect. We were riding through a lush ranch in Salta, Argentina. The gauchos wore what looked like slippers, not at all like the long leather boots American cowboys wear. They were small men compared with the average American, but tough as leather. Their clothing had seen many hard days under the sun, and they wore long knives behind their backs tucked under their belts.
This American investor was able to buy the land at good prices because the Argentines had been through such a nasty crisis that they couldn't wait to unload it. It's as if they'd been wandering in an economic wasteland so awful that when an American came waving some cash under their noses, they could scarcely believe it. Their first instinct was to take the money and run.
Every place has its special genius, its unique gift. In the Pampas, the wide fertile plains of South America, that gift is climate. The growing season is long. It's a great place to grow things. Corn. Tobacco. Alfalfa. Soybeans. This particular ranch had it all, as well as heads of cattle and pigs. In fact, we sampled the latter. Later that evening, we enjoyed a traditional asado, which consists of a variety of grilled meats cooked over an open wood fire. The pig we ate was killed the day before. It was a terrific meal.
You could scarcely imagine a place with more natural advantages. Will Argentina make it back to the big time? I have my doubts, but the potential is there.
Mother Russia: Full of Surprises
Investing in Russia [is] like entering a rich gold field studded with land mines: laced with veins of rich treasure and riddled with pockets of pure poison.
—Mark Mobius, Passport to Profits
In Russia, he who draws the longest bow makes the rules. The powerful and the powerless square off every day—even in the trivial matter of simply getting from one town to the next.
In his fascinating book, Murderers in Mausoleums, Jeffrey Tayler travels the back roads from Moscow to Beijing. (The murderers in mausoleums are Lenin in Red Square and Mao in Tiananmen Square.) As Tayler makes his way across Russia, he notes, at one point, that of the four hours he's been on the road, he's spent at least an hour and a half at six or seven checkpoints along the way. Russian law requires everyone in Russia to carry ID papers in public. Tayler seems to be constantly dealing with officials checking his papers, stamping them, and soaking him for bribes.
Riding shotgun with Tayler, you pick up a lot of anecdotes and snapshots of life in Russia. You appreciate what a seething boil of ethnic tensions exists in parts of Russia. Some of these small republics within the Russian Federation are home to dozens of ethnic groups and languages. They are marked by age-old blood feuds and outbreaks of violence and crime. You come to appreciate how bleak life in Russia is for a lot of people.
Russia has more incidences of tuberculosis and HIV than anywhere else in Europe. Drugs and drinking are serious health problems. Regular terrorist attacks and disasters seem to be happening, killing hundreds at a time: the Kursk submarine disaster (118 dead), the incident at the Dubrovka Theater in Moscow (at least 129 hostages dead), and the hostage situation at a school in Beslan (at least 385 dead). Perhaps it is not surprising that the life expectancy of a Russian male is only 58 years, the lowest in the developed world.
Russia's population falls by about 700,000 people every year. Demographers predict that Russia could slip to only 100 million people, from 143 million currently, by 2050. By objective measures such as health statistics and life expectancy, life in Russia is miserable and hard for most.
Yet Russia holds undeniable investment appeal, despite the perils. As the old Russian proverb says, “It's not the horse that draws the cart, but the oats.”
It was only 2004 when investors lost their shirts in Yukos, the biggest oil company in Russia. The Russian government seized Yukos for back taxes totaling more than $30 billion. The move was widely regarded as a political act, checking the ambitions of its billionaire CEO. Investors howled, but at the end of the day, foreign investors lost over $6 billion.
You would think after that experience, any mention of Russia would be like (as P.G. Wodehouse once wrote) trying to cheer up Napoleon by talking about winter sports in Moscow. You would think Russia's mere name would hurl investors into alternating fits of rage and despair. Not so. Investors are forgiving, or forgetful, or both.
State-owned oil giant OAO Rosneft went public in 2006. What makes this all the worse is that this, in part, is the old Yukos. Rosneft is the company the government folded Yukos into. In other words, it stole this asset from investors and then turned around and sold it back in an initial public offering.
Why the enduring attraction to Russia? Russia's magnetism can be summed up in two words: “cheap assets.”
Russia is still the largest country in the world, in terms of land area. The expanse covers 11 time zones and nearly every conceivable type of landscape, from frozen tundra to hot deserts, from lush, wet lowlands to high, dry mountains, from dense forests to open plains.
And buried amid all that are rich veins of natural resources, Russia is a veritable storehouse of Mother Nature's useful goodies. Russia is the largest, or among the largest, producer of palladium, platinum, diamonds, nickel, and gold. Russia is rich in oil and gas. Rosneft, for example, has more proven oil reserves than Exxon Mobil. It's bigger than any oil company in the world on this basis, save for its sister company Lukoil. It is the world's biggest producer of natural gas.
Eric Kraus is our man in Moscow, where he is a money manager. We'd only swapped emails before, so I was glad to finally meet him in person at the Agora Financial Investment Symposium in Vancouver. I liked his presentation, which included some surprising ideas on Russia.
For instance, of all the ballyhooed BRIC countries, Brazil, Russia, India, and China, do you know which market has done the best over the last decade? Russia. See Figure 11.1.
Now, many people, including me, had worries about investing in Russian companies. As I mentioned above, we all remember what happened to Yukos.
Our Western sensibilities, though, cloud our vision on Russia, said Kraus. A big part of his message in Vancouver was to say that the Western orthodoxy of free markets, democracy, and transparency has little to do with picking winners in the market. The chart above makes that clear. As Kraus put it, “Ideologically driven disinformation can cost you a fortune.”
Still, Kraus used a lot of words you don't normally associate with Russia. Kraus described Russia as “very low risk” with “stable macroeconomics and politics . . . where reform is going on far faster than Europe, but slower than Asia.” Russia is “by far, the wealthiest of the BRIC countries,” Kraus said.
He called it “a middle-income, moderately high-growth (5 percent) middle European country with the world's largest resource base.” It has abundant oil and gas but lots of farmland and fresh water and hydropower. Once one of the world's largest grain importers, it is a top exporter.
Russia has plenty of cash, the world's third-largest foreign currency reserves. Poverty has been cut way down. So things actually look pretty good for Russia. “Of course, the Western press hates it!” Kraus said. “If you have a long-term time horizon, Russia is a no-brainer.” The easiest way to buy Russia is to buy the Market Vectors Russia ETF, which trades under the ticker RSX on the NYSE.
Kraus is particularly bullish on Russia, not only because he thinks the shares are cheap, but because he believes the price of many commodities will rise. “Peak Oil is a mathematical certainty,” he said. Not in the sense that we are going to run out of oil, but that prices will rise as we reach for more expensive sources of oil.
“And it's not just oil,” he continued. “Grades of copper, nickel, and bauxite ores are now being mined, which no one would have bothered digging up a couple of decades ago . . . peak water! A lot of places are running dry, and this will have scary effects upon agricultural prices.
“The predominance of the West is an anomaly in history,” Kraus went on, echoing the thesis of this book. “It ended with the turn of the millennium.” It is a “multipolar world” in ideas and commodities. Instead of the traditional New York–London axis, the economic world will spin on different poles from Beijing to São Paulo.
Central Asia: History's Geographical Pivot
Ukraine and Russia had a nasty spat in 2009, as Russia cut off natural gas supplies to a host of European countries. Tired of relying on Russia, the European Union looked for alternatives. Its eyes wandered to Turkmenistan.
In October 2008, while the world was busy putting out the fires of a financial crisis that still burns, little-thought-of Turkmenistan made a bombshell of an announcement. It seemed to gather little notice at the time. But Gaffney, Cline & Associates, a British consulting firm, completed an audit of Turkmenistan's Yoloten-Osman natural gas deposits. Based on GCA's first results, the fields have a minimum of 4 trillion cubic meters of gas and as much as 14 trillion cubic meters of gas, a truly staggering sum. The announcement put Yoloten-Osman among the four or five largest natural gas fields in the world.
The country's biggest field was Daulatabad, a rich and extraordinary field in its own right. Yoloten-Osman is at least five times as large. Turkmenistan has many gas fields not yet explored.
“Without doubt,” the Asia Times weighed in, “Turkmenistan is closing its gap with Russia and Iran, hitherto listed as having the world's largest and second-largest gas reserves . . . . If the GCA results are confirmed, Turkmenistan will have reserves just 20 percent lower than that of Russia and outstrip Iran by far.”
Turkmenistan has the potential to rival Russia's clout in natural gas and provide an alternative for Europe. By creating a pipeline from Turkmenistan, through Azerbaijan, Georgia, and onto Turkey, the European Union could bypass Russia entirely.
You can be sure the Russians won't like that. Again, from the Asia Times: “[Russia] is no longer the superpower in the world of natural gas, as was widely regarded . . . . Turkmenistan is, unquestionably, a gas superpower of comparable muscle power to Russia.”
The effort to bypass Russia via a southern route is an old game. Tamerlane, the fourteenth-century conqueror of Central Asia, wanted to do the same thing when he sought to divert trade from the northern Silk Road, controlled by the Golden Horde, to a more southerly course through Bukhara and Samarkand (in present-day Uzbekistan).
Today, the five Islamic republics that were once part of the Soviet Union are back on the center stage of geopolitics. Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan, and Uzbekistan all have huge oil and gas reserves. The names sound odd today, perhaps. But someday, Americans will get to know their names as well as they know those of Iran, Iraq, and Afghanistan.
The race is on to court these countries of the steppe, taiga, and desert. In this, China may have a lead, as it often seems to when it comes to securing energy supplies. Beijing offered to finance a pipeline through which natural gas would flow from Central Asia to China. It's doing its best to cozy up to the fab five.
Russia, too, is close to them. Russia relies on Turkmen gas to meet its obligations to Europe, for instance. But the powers that be in old Ashgabat have been sticking it to Russia. They're making Russia pay up for its gas supplies. In 2007, Ashgabat raised the price to $100, from $65, per 1,000 cubic meters. Then in 2008, the price went to $130 and to $150 by June. Today, Russia is paying about $250.
As the Asia Times remarked, “Russia will have to rework its bonding with its Central Asian partners.” It's as if Turkmenistan drew an ace face up, and Moscow is sweating a bit. Turkmenistan has more clout to peddle with eager Americans, Europeans, and the Chinese, who all want Turkmen gas and the opportunity to build out the infrastructure. Russia will have to play the game like everyone else. Turkmenistan is in the driver's seat.
This story goes beyond just Turkmenistan, which is why I relate it to you. It looks like Central Asia will become a grand chessboard of sorts. Some have long seen the region as a key to world commerce and global influence. The first was a British geographer named Halford John Mackinder, widely regarded as one of the founding fathers of geopolitics.
In 1904, Mackinder submitted a paper to the Royal Geographical Society titled “The Geographical Pivot of History.” In it, he developed his “Heartland Theory,” in which he defended the idea that Central Asia would be the seat of global power. Mackinder thought that the Eurasian heartland would come to dominate the fringes, or coastal regions, of the world with the invention of the transcontinental railroad. He thought the Eurasian heartland would be the “geographical pivot of history.”
It didn't turn out quite that way. Today, sea and air power dominate. Most of the world's manufacturing and wealth continues to be found on the oceanic fringes. In fact, over half of the world's population lives within 60 miles of a coastline.
Still, was Mackinder wrong? Authors Ronald Findlay and Kevin H. O'Rourke offer their perspective in their book Power and Plenty. “The railroad has not overtaken the steamship as he imagined it would,” they write of Mackinder, “but the oil and natural gas pipelines of the world, so necessary to sustain all that coastal manufacturing, are increasingly running overland across Central Asia.”
Central Asia, or the Heartland, as Mackinder called it, once again finds that the lifeblood of the West's mighty industry flows over its steppes. “In turn,” Findlay and O'Rourke finish up, “this vital overland trade is raising familiar problems of control over bottlenecks and monopoly power.”
Maybe Mackinder was right after all, in a sense. He was just about 100 years too early.
In northern Iraq, there is the Zagros oil belt, which holds the super-giant Kirkuk field. All around this area in northern Iraq, Iran, Syria, and southeastern Turkey lie rich, prospective, and productive oil fields.
The Selmo oil field, for example, has produced 85 million barrels of oil in its life, the second most in Turkey. Discovered by Mobil in 1964, there are an estimated 600 million barrels of oil in place. Then there are many other prospects and leads in this mostly unexplored country.
The Selmo oil field is 100 percent owned by Trans-Atlantic Petroleum (TAT:amex). It owns other prospective acreage all around southeastern Turkey. I'm not saying that the Turkish acreage is of the same size or as oil rich, as that in Iraq. But Turkey is largely unexplored and offers a big upside and is much safer.
Turkey has abundant natural gas embedded in shale, as in the United States, but the hydraulic fracturing technology is new in Turkey. Trans-Atlantic was the first company to frack a well there. So the idea is that Trans-Atlantic can create the same kind of boom enjoyed by the U.S. shale producers.
Trans-Atlantic, though, enjoys some major benefits over its U.S. brethren, beyond the fact that it has little competition and operates in virginal territory. (Trans-Atlantic's CEO and largest shareholder, Malone Mitchell, said that the level of development in Turkey is like that of the Permian Basin in Texas in 1938. Read: Lots of upside.) Natural gas in Turkey fetches prices more than double those of the United States since Turkey must import to feed most of its growing energy needs. There is no glut in Turkey; the market is tight.
It may be helpful here to say a few words about Turkey, which is fascinating in its own right.
First, let me say that the Turkey of today has about as much in common with the Turkey of 10 years ago as rigatoni con la pajata has with moo goo gai pan. Ten years ago, Turkey was a basket case, waist-high in debt with spiraling inflation, busted banks, and unstable politics.
Today, it is an economically resilient place. It suffered in the 2009 recession, but it bounced back and grew faster than any EU country. From 2002 to 2008, its economy grew by about 6 percent per year.
Young people are economic catalysts, and Turkey is a young country of 72 million people. The average age is only 29 years, compared with 40 for the European Union. About 60 percent of the population is under the age of 35. Demographers predict it will have over 100 million people by 2050, making it the most populous country in Europe.
Foreign investment is flowing in. In the bad old days, investments used to get about $1 billion a year. Today, it's closer to $20 billion a year. Turkish companies make all kinds of things: cars, furniture, shoes, televisions, and cement (of which it is the world's largest exporter). Some call it the “China of Europe” because of its many busy workshops. It is the world's sixteenth-largest economy.
As you might imagine, Turkey's appetite for energy, in particular for natural gas has risen. You can see in Figure 11.2, courtesy of Mazama Science.
You can see the consumption bar stepping up over time. There is no discernible production line because Turkey produces so little, hence the big, yawning net imports. Natural gas is Turkey's fastest-growing energy source.
Overall, the rise in energy consumption reflects the pattern of industrialization we've seen time and time again in China, Brazil, India, and many other places. This big deficit makes energy investing in Turkey attractive because it will welcome you with open arms. Taxes and royalties in Turkey are low because it would like to encourage investment.
Jonathan Callahan at Mazama Science points to Turkey's geographical importance as a transit country. “Turkey has long occupied an exceedingly important geographic location: the bridge between East and West,” he writes. “The Anatolian peninsula is centrally located between Asia, Africa, and Europe.”
That too has helped fuel investment. As way stations along the new Silk Road, once-drowsy towns are springing to life. Read this passage from an Economist correspondent on the city of Gaziantep, the sixth-largest in Turkey, with a population of 1.3 million people:
Until recently, Gaziantep (Antep, for short) was a sleepy, poor, provincial town. A smattering of tourists were drawn by its fortress, its ancient history, the Roman mosaics of Zeugma, the Euphrates River, a few old Armenian churches and houses, and its traditional produce of pistachios, hazelnuts, and what it claims to be the world's best baklava (a sticky pastry).
Antep suffered the same ailments as much of “old Turkey.” The roads were poor. The city was up to its eyeballs in debt. Unemployment was high. Its best days seemed well behind it. (The city is known for its valiant stand against French forces in 1921. Even though the city fell, its heroics earned it the honorific “Gazi,” or “warrior.”)
Today, Antep is booming. Its factories churn out carpets, shoes, packaging, and many other goods. The city ships out more than $4 billion worth of exports per year. The airport is busy. The roads are better. The government offers liberal tax cuts and incentives.
All of this forms the backdrop for Trans-Atlantic Petroleum, whose prize assets are in its huge acreage in largely untapped Turkey.
The other key part of the Trans-Atlantic story is the aforementioned Malone Mitchell, who studied agriculture at Oklahoma State University. It was fellow alum T. Boone Pickens who got him interested in oil and gas. Today, both are rich men with fortunes built on getting oil and gas out of the Earth.
Mitchell made his bundle by building up a company called Riata Energy. He started with a $500 loan in 1984. It became one of the nation's largest privately owned drillers. In 2006, he sold a 46 percent stake to Tom Ward for $500 million. You might know of this company as Sand Ridge Energy. Then Mitchell sold the rest of what he owned in Sand Ridge in 2008 for another $500 million.
Mitchell has seen it all in the oil and gas business, seven busts and six booms over nearly three decades. He's proven adept at navigating the ups and downs of the business. He had the foresight to sell his holdings in 2006 and 2008 while the going was good. What he did with that money was prescient. Trans-Atlantic has been public since 2007. It is Mitchell's latest investment vehicle in the oil and gas business. And he has an idea of how to get rich all over again.
This Oklahoma oilman, who cut his teeth in the oil and gas fields in Colorado and West Texas, decided to go abroad. In an interview with The Energy Report in March 2009, Mitchell explained his thinking:
We started looking about a year and a half to two years ago more seriously at the international market. For the last 20 years, we've seen prospects come to us that, typically, had a number of things in common. There had been a few wells drilled by a large oil company 20 years ago that had what would be considered by U.S. standards very good oil and gas shows, but that had not led to full-scale development by the large company.
Mitchell was intrigued. He studied a number of foreign countries and prospects. He started to form some ideas on what he wanted. He wanted to be in a country that was a big importer of oil and natural gas, so the local powers would look favorably on new domestic supplies, and so he would have an eager and nearby market for his product.
Mitchell focused on areas that allow licensing, rather than production-sharing agreements.” This means you can own your reserves,” he says. He looked for stable governments and low taxes and royalties. Mitchell sought out large acreage positions where he could make big finds. “I like finding oil and gas,” he says. And that's a good thing for investors, because that's where the big money comes from, finding new fields. Mitchell is looking to hit home runs, not singles and doubles.
Mitchell loves Turkey. It is virgin territory. “Drilling onshore in Turkey is like going back in time 50 years,” he says. “During the last upswing in Texas, there were over 800 drilling rigs running. In either Turkey or Romania, you may have no more than 10 rigs capable of drilling at any one time. The level of development here is comparable to the Permian Basin in Texas in 1938.”
He's bringing modern techniques to these new markets, including “fracking” that process of injecting water and sand down a well to break up rock and release gas. That has become something of a lightning rod in the United States, where people worry about the groundwater. Not so in Turkey.
Most of the big players aren't looking at big finds onshore. They are busy looking to grab a piece of Turkey's share of the Black Sea. They think the onshore stuff isn't big enough.
Mitchell thinks otherwise. As he says, Trans-Atlantic owns the second-largest oil field in Turkey. “It's been developed on a density basis of about 5 percent of what any comparable field and reservoir would be in the U.S., so we'll have the opportunity to see if our deeds can match our words.”
Given Mitchell's track record, I wouldn't doubt it.
Economic Impressionism in the Dark Corners
Robert Smith has spent more than 30 years traveling to some of the most troubled economies in the world. Smith and his firm, Turan Corp., trade debt in battered economies. In his book Riches Among the Ruins: Adventures in the Dark Corners of the Global Economy, Smith recounts his experiences in the nascent debt markets of El Salvador, Vietnam, Nigeria, and other tricky places.
For example, Smith was working in Saigon during the Vietnam War. “On nights when the occasional VC rocket would land near my apartment,” he writes, “I'd climb under my bed, where I kept an M-1 rifle I never fired, and wait for things to quiet down.”
Smith's adventures make for entertaining reading, but you get a sense for how the world's markets have changed. Vietnam is a vibrant, emerging market, which we saw in an earlier chapter. And when Smith started in the 1980s, the global debt trade for emerging markets was less than $300 million a year. Today, it's nearly $2 trillion a year. Today's markets are sophisticated, electronic, and global.
Smith's methods are worth keeping in mind. He relied on what he calls “economic impressionism.” It's a fancy word for old-fashioned detective work. It's how he learns about a country, by talking to bankers, businessmen, diplomats, and money-changers. “My education about a country . . . began at the airport,” he writes, “and continued in the cab as I picked the brains of the driver.”
It's not scientific, but his ground-floor view made him lots of money over the years. In my own investing, I've always put a premium on such on-the-ground views and primary sources. (Economists and market strategists babbling away about charts and what they found while grazing on the Internet hold no interest for me.) Smith's success is something to remember as you weigh the research and information you read in making your investment decisions.
Smith's inspirational perspective shows how staying ahead of changes in markets at the fringe and not getting stuck in outdated views can help seed a fortune.
Five Key Takeaways
Mongolia is an exciting market in the early phases of a long, steep growth curve. Check out Mongolia Growth Group at www.mongoliagrowthgroup.com.
Argentina is a wonderful place to visit. Buenos Aires is a great city, and if you want to explore a little further afield, I recommend La Estancia de Cafayate. Find out more here: www.laestanciadecafayate.com/.
Russia is another fascinating market to follow. Keep an eye on the RTS as a proxy for that market. Eric Kraus is my favorite commentator on Russia. You'll find his work here: www.truthandbeauty.ru/.
Turkey has many opportunities in oil and gas. Trans-Atlantic Petroleum (TAT:amex) is a great play on that idea.
Mackinder's lecture is worth reading for the historically minded. Tayler's Murderers in Mausoleums and Smith's Riches Among the Ruins are fun and informative reads.