Several weeks ago, when sharing his latest outlook at the Economist's Buttonwood gathering, Hugh Hendry had this to say about gold miners: "I am long gold and I am short gold mining equities. There is no rationale for owning gold mining equities. It is as close as you get to insanity. The risk premium goes up when the gold price goes up. Societies are more envious of your gold at $3000 than at $300. And there is no valuation argument that protects you against the risk of confiscation.” For those confused, what he means is quite simple: the higher the price of gold goes, the greater the temptation of those extracting it (usually mined in various locales where worker satisfaction with labor conditions is less than stellar - see recent events in South Africa) to strike and demand higher wages (i.e., lower EPS), or of host government to nationalize it. The end outcome is a collapse in the extracting miner's cash flows and profitability, if not outright liquidation. The paradox is that the fewer actual global miners in operation, the better for the price of the actual hard commodity, as less supply means lower price, means greater probability of more miners suffering the same fate, means even higher gold price and so on. But back to the topic of gold miners. Below, for those still confused, is a simple story courtesy of the BBC in 10 pictures, summarizing the bitter dispute over Kyrgyzstan's gold production.
The Bitter Dispute over Kyrgyzstan 's Gold... in 10 pictures:
At 4,000m (13,120ft) above sea level, the Kumtor gold mine in Kyrgyzstan is one of the highest in the world, situated in the permafrost of the Tien Shan mountains of Central Asia. But the beauty of the local scenery is in stark contrast to the ugly dispute over the mine's future. (Photos: Kubat Chekirov, BBC)
There were weeks of protests in Kyrgyzstan following a call for the mine to be nationalised in October. The dispute is essentially about access to the country's rich natural resources and has caused turmoil.
Those who support nationalisation argue that because the mine is frequently the subject of environmental scares, it should be run by the government. They say such a move would guarantee a fairer distribution of profits.
Centerra - the Canadian-based company that runs the mine - is adamant that there is no evidence to suggest that it is environmentally unsafe, despite a highly critical report by the Kyrgyz parliament warning of possible toxic spills of waste water.
The economic importance of Kumtor's mines can be seen by the fact that it accounts for 12% of Kyrgyzstan's GDP and more than a half of all its exports in 2011. The stand-off over its future illustrates deep political divisions in one of the region's poorest countries.
Criticisms over the level of safety at the mine have led to calls in parliament to renegotiate Centerra's contract. While the company admitted earlier this year that it had to cut output at the mine because of "ice movements at the site" it is unlikely to relinquish control without a fight.
A Kyrgyz state commission that is continually monitoring activities at Kumtor has criticised environmental management at the mine, as has the country's parliament which has regularly raised concerns over possible toxic spills.
A recently-released report also warned there could be catastrophic consequences if a dam near the mine was to fail because of earth movement, which in turn could lead to flooding from a higher lying glacial lake.
Supporters of the Kyrgyz opposition nationalist Ata Zhurt party recently took to the streets of the capital Bishkek to demand that Kumtor be handed to the state.
The demonstrations ended with an attempt to storm government buildings, leading to the latest bout of instability in a country which has seen two governments replaced in public uprisings and serious inter-ethnic violence
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To summarize, the biggest losers in this latest gold miner saga will soon be Canadian miner Centerra, which will likely see its local production facilities nationalized, and shortly thereafter the government of Kyrgyzstan, which will find itself less than qualified to run a mine and extract gold with the same efficiency as a private firm dedicated to doing just that. And of course, all those who have been long Centerra stock. The biggest winners: holders of physical gold, as few incremental tons of gold are prevented from entering the market due to government inefficiency, stupidity and greed.