Investing in resource stocks ? assessing country risk | News from the ...

In this blog Dr Dan Packey shares some of his views on assessing ?country risk? in the context of investing in mining shares.

Country risk comprises sovereign risk and/or political risk. It is important to understand these risks as Australian listed companies often have exploration properties, development projects and mining operations in other parts of the world and/or are competing with supply from other countries. Country risk can also affect demand for commodities.

The first level of country risk ? or national risk ? is sovereign risk, which is concerned with a nation?s ability to cover its national debts. A government?s ability to cover its debts gives us some indication of the country?s financial state.? In order to know more, we need to expand the definition of country risk.

The definition can be expanded to include any risks resulting from governmental actions that are unpredictable and unavoidable ? actions that could adversely affect the financial viability of a project, its profitability or the ability to raise funds. Examples could include, changes in regulations, contract breaches, expropriations, not honouring sovereign guarantees and restrictions on currency transfers outside of country.

While all components of country risk are important, not all are considered equal. Different risks are considered important by different groups investing in different countries. Here we provide an overview of what are generally considered the most important components of country risk: land access, land claims, red tape, green tape, corruption, social unrest, infrastructure, civil unrest, natural disasters and labour relations.

Regulatory change often ranks first in investors? concerns in conflict stricken and fragile economies; closely followed by breach of contract and expropriation (MIGA 14, 28). Currently, there is an interest in changes to governmental policy that benefit a particular ethnic group, party or group of people.

Land Access Codes

Land access issues are related to resource exploration and development. There is only so much exploration that can be done remotely. After a certain point, boots must be put on the ground. Land access codes define the guidelines for communication between those possessing exploration authorities and the owners and occupiers of private land. They also impose mandatory conditions on what is the acceptable conduct during the authorised exploration and development activities on private land and reserve lands. Unfortunately, land access codes vary from country to country, state to state and province to province. To get an idea of what they entail, The State of Queensland, Department of Employment, Economic Development and Innovation, 2010, Land Access Codes 2010, provides a good example.

Land Claims

Land claims address issues regarding property (including bodies of water).

They are legal declarations of sought-after control over areas of property. Typically, the ownership of areas is in dispute and/or remains unresolved in the courts. Land claims can be comprehensive or specific. Comprehensive land claims deal with setting aside large tracks of land, usually in a treaty-making process. Comprehensive land claims exist where the determination of (orsetting of boundaries for) aboriginal lands have not been dealt with in the past. (For an example, take a look at the Canadian Aboriginal Land Rights www.aadnc-aandc.gc.ca/eng.) Specific land claims deal with claims related to set obligations that are being (or believed to be) violated. Land claims are sometimes used to refer to disputed territories or to refer to the claims made by displaced people. Examples of this would be native title or aboriginal land claims.

Red (Bureaucracy) Tape

Red tape got its name from the colour of the ribbon used to wrap official government documents. Its origin has been attributed to the English, Spanish, French, Dutch, German and Americans. It appears to be a worldwide phenomenon. Red tape is defined by the Oxford Dictionary as a time-consuming? or complicated set of official rules or procedures. In some cases, there is excessive insistence on rigid conformity to formal rules and procedures. Often the requirement to conform to the formal rules and procedures is considered redundant and hinders or prevents actions. Red tape refers to ?bureaucratic insistence on formality and procedures that can be excessively complex and time-consuming. Hair-splitting and foot-dragging bureaucrats are often accused of relying on too much red tape, the requirements of which often include (among other things):

• filling out paperwork (to the letter);
• obtaining licences;
• filing reports;
• certification requirements;
• reporting practices and procedures;
• investigating practices and procedures;
• inspection of practices and procedures;
• enforcement of practices and procedures.

Red tape is generally seen as a way to discourage applications and to employ large numbers of people in administrative roles.

Green (Environmental) Tape

Green tape is a subset of red tape that focuses on environmental issues. In January 2002, an Australian politician came up with the term ?green tape? to refer to the environmental regulations preventing clearing of vegetation in national parks. As irony would have it, the parks later caught fire from the very vegetation meant to save them. Now green tape is used to describe excessive environmental requirements. According to the Economist, green tape is: the unpredictable and inconclusive manner in which environmental rules are proposed, modified, rescinded and reinstated by bureaucracy and the courts. (www.economist.com/node/21547804.)

Corruption

Transparency International (TI) defines corruption as the abuse of entrusted power for private gain. This definition includes corrupt practices in both the public and private sectors. The joint sector corruption perceptions are provided below with other areas.

For those interested in public sector corruption the Corruption Perceptions Index (CPI) ranks countries by the degree to which corruption is perceived to exist among their public officials and politicians. It is an aggregated index using data from 17 different sources. The CPI ranks countries from 1 to 10, with 1 being the most corrupt and 10 being the very clean. The entire report can be found at:

www.transparency.org/cpi2010/results

?Social Risk

Social risk is a catch-all phrase that deals with societal situations not covered in labour relations or civil unrest that can still negatively affect an operation.

Lack of community support, protest movements and marches, interference with workers and invasion of property are examples of social risk. The interruption of the Parisian economy by disgruntled farmers driving tractors and clogging the highways and byways of France is a good example. Such occurrences can inhibit the flow of inputs and outputs. The frequency and duration of the protests can have a negative effect on the production (and profitability) of an operation.

Infrastructure Risk

Infrastructure is the basic fundamental physical and organisational structures necessary for a society or an economy to operate. Examples include (but are not limited to) roads, rail, airports, ports, mail service, banks, bridges, telephonic (and web) access, police, fire-fighters, medical care, education.

Everything necessary to establish markets for the necessary goods and services in a community is covered under the term ?infrastructure?. To this list Laznicka would add language ability; the ability to communicate with the local population or institutions. A component of country risk is a nation?s lack of necessary infrastructure to allow a company to operate efficiently.

Civil Unrest

Riots and terrorism are the two most dramatic examples of civil unrest. Civil unrest can affect projects through destruction of assets, reduction in inputs (including labour), damage to infrastructure, institutional and regulatory frameworks and significant reductions in demand. The Arab Spring is a dramatic example of civil unrest and the damage it can cause. The demonstrations known as ?Arab Spring? began on a Saturday, the 18th of December 2010. So far, the following countries have been involved:

Tunisia, Egypt, Libya, Yemen, Bahrain, Syria, Algeria, Iraq, Jordan, Kuwait, Morocco,???? Oman, Lebanon, Mauritania, Saudi Arabia, Sudan.

Although, the last four (Lebanon, Mauritania, Saudi Arabia and Sudan) have experienced relatively minor unrest.

Natural Disaster Risk

Natural disasters are events that lay outside the control of humans. They are forces of nature. The frequency and severity of earthquakes, flooding, hurricanes (cyclones), forest fires, disease pandemics, sandstorms, tornedoes and monsoons are all controlled by nature and can change the riskiness of a project. Some areas have detailed records of natural disasters available; others do not. Where records do exist they should be examined for patterns. For areas without formal records, local verbal histories may need to be considered.

Labour Relations

Labour relationship addresses the mental and physical state of the work force. The labour force can be available and willing to work or it can be disenfranchised and prone to strikes or work stoppages. Labour forces can be organised and politicised or not. Many factors determine the quality and efficiency of the labour force and they include (among others):

> health;

> education;

> training;

> special skills;

> customs.

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This is an excerpt from the new book by Drs Allan Trench and Dan Packey. If you?ve enjoyed reading today?s blog, you might like to read more of ?Australia?s Next Top Mining Shares?.

Disclaimer: The material in this blog and the publication we are referring to is of in the nature of general comment only, and neither purports nor intends to be advice. Readers should not act on the basis of any matter in this publication without considering (and if appropriate taking) professional advice with due regard to their own particular circumstances.

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Source: http://lesleyaw.wordpress.com/2012/07/18/investing-in-resource-stocks-assessing-country-risk/

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