XROSSBRIDGE VENTURES INC. JUNE, 2008 Min ing in As ia Show us the METALS, China! Many senior mining firms pulled out of China in the mid nine- ties for a number of reasons. The most prevalent of these was the apparent lack of regulations toward ownership and in- vestment in properties. These have since been addressed via the Chinese government changing their laws to emulate those GO WEST! of North American Mining standards. These laws and regula- MINING IN CHINA! tions principally started being implemented and enforced in 2002. So, are foreign mining companies truly ready to enter China? Topics Covered in Paper What is holding them back? What is the right approach? Who is responsible for executing the correct growth models in •DISAPPOINTMENT IN THE TSX •OBTAINING A LICENSE TO China? What are my top picks for investment in China? MINE •TIMEFRAMES •BIDDING REGULATIONS Get to the point! The reason that the Peoples Republic of China (PRC) has not •INVESTMENT CLIMATE •MY TOP PICKS thrived in the eyes of the North American mining investor is •FUTURE OUTLOOK lack of due diligence! Profound I know, but there is an overwhelming lack of legal and accounting parallels to that of a North American struc- MY CHINA MINING TOP ture. The human body is lazy and in many aspects it is easi- PICKS & WHY! er to dismiss than hold the torch and lead the way. But I have found torchbearers doing just this with great success in China. These being Goldrea Resources Corp.(TSX.V- GOR), Golden China Resources (recently acquired by Sino Gold - ASX- SGX) and Jinshan Gold Mines (TSX-JIN). I will explain why on page 5 of this document but first a little education on the mining approval process in China. Disappointed in the TSX! China basically dominates the world as being one of the pri- mary producers and consumers of almost all metals: precious, base and strategic. Foreign investment has tried to enter the Chinese Mining forum for some time with little success. This has given a sense that China continues to be a high-risk investment climate toward mining. I am generalizing but with my tenure in dealing in the China mining environment I feel I can speak from my experience. Quite often perception is re- ality and therefore I feel that this stems from the very top of the Canadian investment community, meaning the institu- tions and exchanges themselves. The fact is that China is huge and continues to grow at a tremendous rate. China holds XROSSBRIDGE VENTURES INC. Show us the METALS, China! XROSSBRIDGE VENTURES INC. JUNE, 2008 the single most mineral investment growth opportunity in the world and is likely the last true frontier for mining potential we will witness in our lifetime. So then, why has the Toronto Stock Exchange not set up a local office in China to deliver these offerings to Cana- dian investors? A tremendous shift has taken place in the last three years within the Chinese mining invest- ment community. These assets were constantly looking at outside sources of funding in order to progress but now more and more of them are being funded internally as well as internation- ally by Chinese individuals. We are missing out on these investment opportunities and as a result need to look to our brokerage firms. They are slowly setting up offices in order to take paper on these deals; however, the majority is not seeing the best investments. On the other hand, Asian investors are proving my theory that they have tremendous buying power and the exorbitant valuations of the oversubscribed mining listings on the Hong Kong exchange are but one of these indicators. There is no doubt that China will be self-sustaining in the very near future. Once the PRC government regulations toward capital markets become more developed internally the international investment door will become infinitely smaller for the North American retail investor. China currently has over 100 million people (7% of total population) that make an income comparable to the average North American. I am extremely disappointed in the Exchanges efforts to educate and facilitate sound investment practices for individuals looking to invest in China so I am taking on this responsibility myself. Commencing in June, I will be releasing a monthly newsletter on topics individual investors must know in order to invest successfully in China. I will also highlight the risk vs. re- ward in my comments. You may also contact Annie Tau - The Toronto Stock Exchange Chinese contact fro China investors @ 1-(888) 873-8392. She will be able to provide any legal mate- rials pertaining to mining regulations in China. I plan on issuing a series of papers ex- plaining the process and will provide other resources you may need in order to clear up any ambiguities that individual investors may have regarding mining investments in China. The beginning of this series will start with the basics of how one may obtain a mining license in China. Obtaining a mining license! (Ministry of Land and Natural Resources (MOLAR)) is the Chinese regulatory body for all min- ing assets and processes in China. MOLAR has been diligent in implementing new laws and reg- ulations since 2002 to reduce barriers of entry for foreign investment and promoting interna- tional mining standards. These efforts are now proving to be successful for MOLAR and for- eign investors alike. Obtaining a Mining License in China A foreign mining company may obtain a right to mine by: • entering into a joint venture with a domestic entity that contributes the mining rights in return for an investment in the joint venture (not activated until funds, license contributed); • purchase directly from a domestic entity in accordance with China’s regulations; • first obtain an exploration license, and, after discovery of a viable asset, apply for a right to mine; or • obtain the right through the tender, auction or bid process 1 Step 1 Where initial exploration work reveals a deposit worthy of development, the exploration license holder may apply to discontinue the minimum exploration expenditure required under the terms of the exploration license and applies to reserve the exploration rights. 1 Exploration and Mining Rights, Tender, Auction and Bidding Management Tentative Procedures, by MOLAR June 11,2003 and Effective August 1, 2003. XROSSBRIDGE VENTURES INC. Show us the METALS, China! XROSSBRIDGE VENTURES INC. JUNE, 2008 The reservation period is two years and can be extended twice for a further two years each time (for a total of six years). Although the minimum exploration requirements would be halted, the license holder is still required to pay the exploration fee.2 Step 2 The exploration license holder applies to MOLAR for approval of the mining area bounda- ries.3 Step 3 The exploration license holder then works with a qualified appraisal organization that is managed by, and reports to, MOLAR to produce a mineral deposit report that must be evaluated and reviewed by the appraisal organization and reported to the Geological Mineral Department of MOLAR4 Step 4 The next step is preparation of a mining project proposal and feasibility study and es- tablishment or, if required, application to restructure the exploration entity into a mining entity. Whether this application is made to the Ministry of Commerce at the central or pro- vincial government level will depend on the size of the project and the type of mine that is pertinent to the application. There are restricted materials in China, which a foreign enti- ty can not control, Uranium being one example. Other metals such as zinc deposits that are less than US$30 Million (or projected value over this amount) which are classified in the domestic provinces as “encouraged”, may be approved at the provincial government level. The State Development and Reform Commission (SDRC) at either the local, provincial or state level (depending on the size of the asset) must approve the feasibility study. The SDRC also en- sures that the mining entity holds the correct qualifications to mine. The registration pro- cess is continually upgraded and kept in compliance through good mining practices and princi- ples like that in the Western mining world. Step 5 A mineral resource development utilization plan5 must be carried out by the company. The company (mining license holder) commissions a certified mining design organization to com- plete this stage. Pending the proposed capital investment in the joint venture and the out- come of the findings of the “mineral resource development utilization plan” additional ad- justments may be made to the JV company. This would require further approval by the Ministry of Commerce. Step 6 A license holder submits the following to MOLAR in order to gain the right to mine:6 • an application form and detailed map of the area with boundaries; • eligible applicant proof - meaning these individuals have the correct certificates, technology, experience, equipment and access to funds; • a qualified design organization guarantor plan for mining and utilization of the re- sources; • the business license of the joint venture or wholly foreign-owned entity (WFOE) mining company; • an appraisal report if the deposit was found by exploration, funded by the state or, where the right was obtained through; 2 3 Administration of Registration of Mineral Resource Exploration Blocks Procedures (February 12, 1998), Article 21. 4 Administration of Registration of Mineral Resource Exploration Blocks Procedures (February 12, 1998), Article 4. 5 Provisions for the Evaluation and Confirmation of Mining Deposits (May 15, 1999), Article 3. Notice of Relevant Provisions regarding Mineral Resource Exploration and Mining Registration, Article 2(2). 6 Administration of Registration for Exploitation of Mineral Resource Procedures, Article 5. XROSSBRIDGE VENTURES INC. Show us the METALS, China! XROSSBRIDGE VENTURES INC. JUNE, 2008 • an environmental impact assessment document and approval from the environmental gov- ernment agency; • other specific documents may be required pending the province the asset is located in. Step 7 Once the process is approved, a mining royalty fee must be paid within 30 days of receiv- ing the approval notice. When payment has been received, the right to mine will be granted and issued to the applicant. Timeline of the entire process Timelines can vary greatly. I have personally been involved in transactions in Gansu, Xin- jiang (the western provinces) where the approval time takes a fraction compared to that of the eastern provinces, but generally speaking one can expect the initial applications for the mining area boundaries to take 60 days. The feasibility, mining restructure, approval and authorization can take anywhere from 60 to 180 days. The final mining application generally takes no longer than 50 days to make it through the system and the payment and issuance of the license to mine will take an additional 30 days. The Bidding Regulations In 2002, Molar implemented three principle methods for Chinese and foreign mining companies to obtain exploration and mining rights. These are auction, tender or bid. There must be more than three bidders; the winning must be higher than the reserve set by officials (pend- ing size of asset this can be provincial or state bureaus whom commission the valuation re- ports) or in the case of state owned mining entities government officials’ value the mining rights to be auctioned. This can be open to the public if a Public Notice has been given which must be circulated at least 20 days in advance of the auction date. Tender compli- ance is similar to that of a public tender process in North America. A Notice will be posted 60 -90 days before the tender closing dates. Each participant will complete and file the ten- der package to the offering office. They will each be reviewed based on overall merit of the proposal and the appropriate bidder will be awarded the tender. Also, like that of North America, there must be at least three tenders submitted in order to deem the tender process valid. If not, the tender will not be successful and the process must commence at the begin- ning. The bidding process for mining rights includes a Public Notice posted 20 days in ad- vance of the beginning of the “bid period”. The bid period runs for 10 days. On the begin- ning of the bid period, bids will be submitted and posted at the venue chosen to display the bid until it is replaced by a higher bid. The highest bid at the end of the 10-day process will be considered to have been awarded the mining rights. As stated these three methods are not necessarily used in every instance. It is noteworthy, that they are used for the alloca- tion not for extensions, renewal, or rights. These methods are not used for current license holders who have not proposed changes deviating from the original exploration boundaries de- fined in the license. If any of the following terms are not met then a bidding method will be applied for the min- ing rights; • mining rights previously held by an party and have expired; • exploration rights have expired but there is historic data which supports there is a viable asset; • an instance where the state funded the exploration, and a viable deposit was discov- ered; • at the provincial or state level MOLAR approves one of the methods to be used; or XROSSBRIDGE VENTURES INC. Show us the METALS, China! XROSSBRIDGE VENTURES INC. JUNE, 2008 • the government authorities declare that the specified ore can be mined without the need for exploration. Just because an entity obtains a Right to Mine via one of these methods does not make it binding. They must enter into an agreement confirming the terms and conditions of the mining rights approved. If this is not signed within a set timeframe (varies per province) the min- ing rights becomes void. No foreign company can bid directly on any asset! They must set up either a foreign invested corporate entity, establish themselves as a Chinese entity or set up a representative office in order to be eligible in the bid process and meet pre-qualification terms. There is little information on qualification standards in order to be involved in the bidding process. This for the most part, is one of the only “GREY” areas. The other regulations clearly state all the equipment, technology and appropriate finding obligations which are required to qualify. Concerns with the current mining environment in China Project approval process An accepted mining practice for international companies interested in a JV with a Chinese firm works like this: A comprehensive agreement is forged first to include all the areas of major business issues in the future with regards to exploration, feasibility, employees, in- frastructure, construction development and future areas of partnered development. Investment is committed for each stage of the combined development and once those criteria have been achieved funds are released to execute the next stage. China currently has an appropriate approval process depending on the industry and size of the project. This is almost impossible for the exploration side of mineral deposits as this is unknown. An exploration party may intend to spend $10 million, yet find absolutely nothing. The risk here is that a project may be approved at a provincial level then when the deposit is realized a different form of valuation will be implemented by the federal level and the project term will be changed. This is slowly being corrected by implementing MOLAR approved provincial and state agencies that work on arms length valuation of both private and state controlled assets. Corporate Structures There are a couple corporate vehicles available to foreign mining firms. One being a pure PRC company registered in Hong Kong where the legal process is quick, clear and currently enforced. This is not the most advantageous from the North American markets perspective; however, it is litigiously speaking a very good structure. The second accepted vehicle is a Joint Venture and third being a Wholly Owned Foreign Entity (W.O.F.E.) where by foreign in- vestors must register capital into the vehicle with terms applied. This is not beneficial since before any exploration happens investors have to escrow their capital into this struc- ture. This is a fairly large deterrent when trying to qualify to explore or mine. As explo- ration companies are generally short on cash this is just another layer of complexity. If the initial geological date is not favorable they must be able to reduce their capital in the vehicle and move to “greener fields”. This is not easy in China as reducing capital in the vehicle is subject to approvals are lengthy and in the public markets can greatly hinder the momentum. Priority Rights (who gets the deposit) Like many developing countries, the country of origin always struggles with the correct growth strategy when it involves foreign investment and development. There is a long list of developed Countries; Canada, Japan, former Soviet Union and the United States that have all suffered these growing pains. There are many instances where individuals have purchased land XROSSBRIDGE VENTURES INC. Show us the METALS, China! XROSSBRIDGE VENTURES INC. JUNE, 2008 in these countries only to have it ceased by the government. Therefore with the precedent set, foreign investors are concerned that by investing in exploration in China the company might make a notable discovery but not be granted the right to mine. The PRC Mineral Re- source Law Implementation Rules state that “the exploration right holders have a ‘privileged priority’ or ‘priority right’ to obtain the mining rights to mineral resources within the exploration area.” China is not the only mining jurisdiction, which has these conditions in place. Therefore investors must do their own due diligence. It is important to meet all the pre-qualification terms and leave no room for discrepancies. I have not heard or been part of any misguided investment in the past with regards to granting mining rights to the explo- ration company after following due process and providing transparency to the government. Taxation The Chinese use a derivative of the somewhat unorthodox French corporate structure for their taxation system. The taxation laws specific to mining and exploration vary depending on the province so be aware of this. For example the “GO WEST” concept implemented in 2004 where western provinces like Xinjiang, Qinghai, Xizang (Tibet), Gansu, Inner Mongolia, Sichuan and Ningxia allow exploration expenses to be amortized as a carryover asset into the mining stage and are provided tariff and VAT exemptions for imports of equipment under specific condi- tions. This has proved successful and has brought a great deal of investment into these in- credibly poor socioeconomic areas. Note in order to gain these exemptions and approvals one must have an approved up to date exploration and or mining license. China is notorious for verbal confirmation which I have witnessed can go either way, but in order to mitigate risk I suggest getting written conformation and not going on faith alone, although this is part of the culture. Asian auditors will be required to translate to North American auditors via their affiliate program in order to get a GAAP audit completed. There is constant confusion regarding the complicated tax and royalty infrastructure currently in place, as it has not been developed enough to make a seamless transition to North American GAAP and the explora- tion deductions and large capital outlays for a sizable mining project. I can conclude that the reporting has come a long way in five years and that China is almost there. However I would advise before investing anything in China one should understand the accounting differ- ences and deal with local North American auditors who have a direct office or a notable af- filiate in China. Please note that the big three accounting firms do a good job but there are smaller firms like Schwartz Levitsky Feldman LLP www.slf.ca in Canada which do very good work as well. Geological Data Although China is the most democratic, communist country I have conducted business in, it is still secretive as to its natural resources. So access to past geological data is hard to find. In most cases one has to work with the local military brigades who have gathered most of the geological data in the past century. Depending where you are looking to invest most of the data will be in Chinese. If looking west at southwestern China this data will be in Russian or possibly German as many Germans were interested in Tibet prior to occupation by China. If you are looking for base metals, Tibet is well known for it’s ample supply of lead, zinc and copper among others. China Mining Management Public Markets Perception Traditionally these producing mining assets are run 100% by Chinese nationals via old mining methods. The perception of the public markets is instant wealth. There is little to no un- derstanding of the compliance associated to running a public company by current management and chances are none of them have ever been part of a public company in the past. There is XROSSBRIDGE VENTURES INC. Show us the METALS, China! XROSSBRIDGE VENTURES INC. JUNE, 2008 however an unstoppable force for success by the Chinese, something that you can feel when you are there, a billion plus people all working toward one goal to be (or have) the North Ameri- can lifestyle. This is hard to quantify but I guarantee they are learning and they do have the biggest mineral growth potential left on the globe. As little as five years ago the Chi- nese were having difficulty with foreign investment in China and now most of the orders are being filled internally. It will not be long before China will be self sustaining and will have no further need of foreign investment and North American investors will have limited opportunity to gain a share in these vast resources. China Mining Summary As investors China has become a place where we “must invest” it is not a matter of “if we should invest”. China is currently the largest Gold producer and climbing fast. It also ranks at the top in not only consumption but also production of tungsten, copper, lead, zinc, vanadium, manganese and molybdenum, etcetera for all precious, base and strategic metals. Their is no sign of it slowing down in the next 5 years at which time India (which shares borders with China) will be reaching it’s stride from an infrastructure growth perspective and any base metals used in the production of infrastructure materials (steel, wire, cement, fertilizers etc.) will continue to be in demand. I have written many reports on China and tracked almost every public company that have either dipper their toe or jumped head first into these waters. I have seen a few successful ventures over my tenure and will discuss my picks in the closing paragraph below. My Choices for Chinese focused mining firms and why! In my opinion successful ventures in China are defined as being currently in production and should have a proven mining management team with international experience. Due to the fact that the Toronto Stock Exchange is home to more than 60% of the worlds mining companies I will use these companies to outline my idea of a good approach and therefore a good start toward investing in China. I would not look to junior exploration companies only unless you are a high-risk educated investor. This approach will take 8-10 years to get in to production via traditional NA methods and by then I am not sure what the state of the mining environment in China. Meaning restricted metals or restricted high grades or change of land lease terms etcetera. My top choices I would consider to invest and learn the industry are Goldrea Resources (TSX- GOR), JinShan Gold Mines (TSX-JIN) whom is partnered with Ivanhoe Mines (currently has the worlds largest copper-gold deposit in Mongolia and Golden China Resources (www.goldenchina.ca) whom was just purchased by Sino Gold (ASX-SGX). I believe these are good companies to track and watch. (There are many others depending on your investment style but I do not feel they have as much growth opportunity in a short timeframe.) My reason be- ing, all of them have great mining management. Larry Reaugh, President and CEO of Goldrea Resources has 42 years mining experience and has brought 4 mines into production. He has chosen to grow in China with acquisition of a producing State owned asset. While this is good for the mitigation risk aspect the only drawback is the amount of time it takes to fi- nalize a state owned acquisition. This can currently be seen reflected in the GOR stock price but this also marks a great buying sign for investors. I have stayed away from state owned assets in the past but it is proving to be a good choice for Goldrea and will no doubt be an attractive takeover for a major looking to establish itself in China and expand on an already sound footprint. Now we have recently witnessed this happen to Golden China which was acquired by Sino Gold (looking to be China’s lowest cost large scale gold producer with 8 million ounces of resources in China) I have known Doug Betts, Grant Chen and Gary for some XROSSBRIDGE VENTURES INC. Show us the METALS, China! XROSSBRIDGE VENTURES INC. JUNE, 2008 time and although their momentum was not in line with what North American institutions would have liked they were persistent and worked with the Chinese culture and it paid off for their shareholders. Now Jay Chmelauskas, CEO of Jinshan Gold Mines (TSX-JIN) is doing what most exploration firms do, scooping up vast numbers of land leases but in this case Jinshan is not a junior and is acquiring good valued assets at a fast rate with a good team behind them. As we all know every market has consolidation at some point in time and he who has the biggest assets wins. I like what JIN is doing and would continue to watch all of these stocks. These changes and increased understanding of these laws has helped a great deal over the past five years but there continues to be uncertainty and doubt as to repatriation of finds and a reporting standard that does not have exact parallels. Therefore there seems to be always a bit of a lag in translation, this is due in large part to a huge cultural difference and lan- guage barrier. I myself have been performing RTO’s and M&A work in China for 10 years now and have seen the industry come full circle. So without sounding biased I am not blaming the Chinese for these discrepancies I would rather highlight the fact that the North American markets need to do some educational promoting as to a good risk mitigating structure and due diligence practice much like you would do for any deal in North America. I will continue to choose topics to discuss and feel free to contact me directly with any question on China and mining. Before you invest please read the following links www.chinamining.org/Investment/2007-06-27/1182925046d5838.html China’s Policy on Mineral Resources www.chinamining.org/Investment/2006-08-04/1154674314d441.html Main Policies on taxation and finance www.chinamining.org/Investment/2006-07-25/1153813527d201.html Overview of the economics of Mineral resources www.chinamining.org/Investment/2006-07-25/1153813195d199.html Characteristics and distribution of China's mineral resources www.chinamining.org/Investment/2006-07-25/1153812794d198.html Overall Good links on this site with updated material www.goldrea.com International Trade laws and mining in China www.mofcom.gov.cn About The Author Gavin Treanor writes investment analysis on behalf of undervalued companies. Gavin started his career in Aerospace Engineering and has been involved in private placement and IPO fi- nancing for over 10 years. In performing due diligence for the readers we have conducted independent research outside of the company information provided in order to validate and clarify terms and forward looking statements. This report does not imply a recommendation to buy stock. Please speak with your investment advisor for such recommendations. A fee was paid for this report to be completed to the author. The author may buy or sell stock of RD from time to time. To discuss this report please call Gavin Treanor at 905-315-7715. Disclosures Xrossbridge Ventures Inc. charges fees to companies covered by individual research reports or continuous coverage. These fees cover costs of identifying and analyzing potential opportu- nities, constructing financial models and writing fact-based research. We seek to correlate industries and show transparency in order to allow investors to understand the workings and key drivers in the specific sectors of interest. We also provide access to dynamic financial models for a growing investment base. In order to insure quality, independence and objective research, we abide by the standards of Professional Practice of professional Engineers among other Professional Standards in ethics. Fees are charged to undervalued companies seeking exposure on their assets. All editorial decisions are under the control of the author. Xrossbridge Ventures Inc. makes no represen- tations as to the accuracy, completeness or correctness of its research. Opinions and esti- XROSSBRIDGE VENTURES INC. Show us the METALS, China! XROSSBRIDGE VENTURES INC. JUNE, 2008 mates are subject to change without notice and have been provided in good faith and without legal responsibility. Our research is not an offer to buy or sell securities. Xrossbridge Ventures Inc. and its analysts accept no liability whatsoever for any direct or indirect loss resulting from any use of our research. 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