Russians Mine for Gold in Hong Kong

The Russians are coming — and bringing plenty of baggage with them. The first Russian company to be listed on the Hong Kong Stock Exchange looks likely to be Strikeforce Mining and Resources (SMR). Auditors and investment bankers are now doing due diligence on the company, whose main operation is the mining and refining of molybdenum, a minor but important metal used for hardening steel and making it corrosion resistant. It is particularly used for steel for oil and gas pipelines.

The Hong Kong Exchange, thanks to its mainland focus, has so far missed out on Russian and other foreign listings which have flocked to London and elsewhere and is keen to see it listed, so for once the Russians can be assured of a warm reception.

Strikeforce will of course have a good story to tell: Of a buoyant molybdenum price which has risen from US$10 a pound to $33 over the past three years; of demand exceeding supply for many years into the future as producers and users alike rush to build oil and gas pipelines from remote central Asia and Siberia to China, India and other fast-growing energy users.

Strikeforce is the major producer of molybdenum in Russia, which is facing a shortage of the metal. The company will also doubtless tout the location of its main mine at Zhirekan, close to the eastern Siberian city of Chita, the last major stop on the Trans-Siberian Railway before it enters China’s Heilongjiang province. It also has another deposit further west — in the Khakassia Republic in southern Siberia near the Mongolian and Chinese borders. China’s own molybdenum production – much of it from HK listed Hunan Non-Ferrous Metals Corp – is static and demand is rising fast.

So far, so good. However, investors may need to be wary of three issues. The first is Strikeforce’s corporate antecedents. It is part of a huge conglomerate called Basic Element, which is run by one of Russia’s leading oligarchs, Oleg Deripaska. Basic controls Rusal or Russian aluminum, the world’s second largest aluminum producer. Deripaska bought part of his stake from Roman Abramovich, owner of the Chelsea Football Club. Rusal is also partly owned by an even more famous Russian oligarch, Viktor Vekselberg. This is the same Vekselberg who, together with fellow oligarchs Mikhail Fridman and Lev Blavadnik, is in a long drawn out dispute with BP, the British oil giant, for control of TNK-BP, an integrated oil company which has vast reserves in Russia.

Vekselberg is one of the tycoons who have so far managed to stay on the right side of Vladimir Putin and the state seems to be helping him in his power play with BP, which owns 50 percent of BP-TNK. Numerous BP technical personnel have been refused work visas and the British head of the company is now being subject to a tax audit. Such is business in Russia.

Strikeforce may be too small to get embroiled in this sort of mess but outside investors should be aware that they face limited recourse in Russia, and even less when they own only 25 percent of a company – the percentage of Strikeforce likely to be listed.

But assuming that Strikeforce sticks to its molybdenum business and stays out of Moscow tycoon politics, other dangers lie ahead. The first is that much global molybdenum production is secondary – it is a by-product from mines producing copper and other metals. This supply can and will grow regardless of the level of investment in molybdenum dedicated mines. Prices may stay high for another two three years but are vulnerable.

Next is the sheer number of large molybdenum projects now in the works. One big one is opening soon in Australia, and others in Canada that were mothballed during years of low prices are being brought back into production. Further down the road are big new projects in Russia itself. Not far from the Strikeforce mine in Chita is a gigantic project known as the Bystrinskoye deposit, owned by Norilsk, the biggest of all Russian metal miners, which has gold and silver as well as molybdenum.

Norilsk’s resource estimates were approved by the Russian authorities last December, giving it the go-ahead for a project that should be producing by 2011 and that is being supported by a new railway being built with government funds. Another large, low-grade deposit exists near Ulan-Ude, to the west of Chita, and there are also deposits across the border in Mongolia. The world is not short of molybdenum ore. The issue for new projects is whether size and grade and byproducts such as gold justify the mining cost and infrastructure investment.

Molybdenum has a history of brief price spikes. In 1995 it jumped from US$4/lb to $15 before falling back below $5 where is stayed till 2003. This time the rise has been long sustained but a fall back below $15 looks all too likely on a three-year view.

Investors in Strikeforce may also need to wary of possible environmental issues. Russia is becoming more sensitive to pollution problems and high-profile tycoon groups can be especially vulnerable if they fall out with political leaders local or central. Basic Element is currently facing accusations that a large paper mill that it owns has been ignoring environmental rules and pouring vast amounts of pollutants into Lake Baikal – the world’s biggest freshwater lake, which lies to the west of Chita.

Novelty plus the global minerals boom is likely to assure that Strikeforce gets a good investor reception, raising perhaps US$200 million for its owners. But if Hong Kong investors really want to punt on interesting but little known non-ferrous metals companies, they might do better to try Hunan Non-Ferrous which has tungsten, zinc, lead, antimony – and molybdenum.