Frontier investing promises growth
opportunities that developed-world economies just can”t offer. The flip side is
that investors often have to stomach the messy politics of emerging-market
nations.

Mongolia is a case in point. The
resource-rich country—whose economy grew 15% in 2011—has drawn plaudits,
investors and the attention of bankers in the past couple of years. Global
mining giant Rio Tinto is heavily invested there and this week spent another $1
billion to fund the Oyu Tolgoi copper and gold project. In February, Goldman
Sachs Group took a 4.8% stake in one of the country”s top three banks. Hillary
Clinton, during a visit last month, lauded the country”s burgeoning democracy.

But too much optimism ignores the political
risk. The canary in Mongolia”s coal mine is SouthGobi Resources, a Hong Kong-
and Toronto-listed coal miner spun out of Canada-based Ivanhoe Mines. In April,
Aluminum Corp. of China, or Chalco, agreed to buy Ivanhoe”s remaining 60% stake
in the company for $926 million, a precursor to a takeover.

Then the politicians got involved. With an
election looming, the government introduced new foreign ownership legislation
that effectively blocked Chalco”s plans.

Behind the mess is Mongolia”s complex
relationship with its giant neighbors, Russia and, especially, China.
Landlocked Mongolia needs China for trade—including the transport of natural
resources out of the country. But Chinese power looms as large as the potential
riches it offers.

State-owned Chalco extended the deadline
for its offer by 30 days last month, and on Thursday said it would extend the
agreement another 30 days more “as additional time is needed to engage
with the Mongolian government.”

In the meantime, SouthGobi is in limbo.
Operations at its main mine have ceased as Mongolia”s government departments,
from tax to the environment, stall on handing out necessary permits and
sign-offs. Its workers are sitting at home on reduced pay. The Hong Kong-listed
shares have fallen by about 50% from before Chalco”s offer.

The stalemate will likely be broken only by
a change of heart in Mongolia”s capital, or, maybe, a competing bid from a more
palatable, Western buyer. Neither, though, seems imminent.

Pioneers that piled into SouthGobi”s stock
should have been aware of the potential political risks. Chalco should have
known its attempt to buy up Mongolian assets would cause a stir.

Other investors contemplating Mongolia”s
frontier market should learn from their mistakes.

By
Duncan Mavin

Wall
Street Journal