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Oct. 19, 2009, 12:12 p.m. EDT

Metal Miners in Mongolia Dig In

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By Ellen Sheng

<DJLINK TYPE="INTRADOC" LINKEND="mark">(See Corrections &amp; Amplifications below)</DJLINK>

HONG KONG -- Some foreign investors hope the sprawling desert country of Mongolia will become the next big resource story, following a landmark agreement with the government to develop one of the world's biggest copper-and-gold deposits.

Earlier this month, Mongolia's government signed a deal with Canada-based Ivanhoe Mines /zigman2/quotes/207656050/delayed CA:IVN -0.17% Ltd. to develop the US$4 billion Oyu Tolgoi project.

Ivanhoe Mines recently struck a deal with the Mongolian government to develop the Oyu Tolgoi copper and gold mine, shown in 2007.

The deal, which also involves mining giant Rio Tinto /zigman2/quotes/222358280/composite RTP +2.93% PLC through an investment in Ivanhoe, helps clear up uncertainty over taxation and government involvement and lays the groundwork for more foreign investments.

Mongolia, a sparsely populated, landlocked country tucked between China and Russia, has some of the world's largest untapped reserves of coal, copper and other commodities. At least 24 other resource deposits are waiting to be developed and privatized. It has an estimated 62,000 tons of uranium reserves -- the world's 15th largest -- and total coal reserves of about 100 billion tons.

The Mongolian government hopes to attract $25 billion in foreign investment in the mining sector over the next five years.

So far, political and regulatory uncertainties have kept Mongolia out of the global commodities boom. Concern about the potential damage mining could inflict on the environment has also spurred public opposition to foreign investment in the past.

Negotiations with the government regarding Oyu Tolgoi dragged on for six years but finally became serious earlier this year after the government announced it would scrap a 68% windfall tax on sales of copper and gold.

The government also classified terms under which it can take a stake, eliminated provisions for value-added tax and clarified some issues related to resource and water use. Under the deal, the government will own a 34% stake in the mine.

Keeping close tabs on the Oyu Tolgoi project, global private-equity firms such as Oaktree Capital Management LP, Franklin Templeton Investments /zigman2/quotes/201997162/composite BEN -0.22% and Carlyle Group LP have talked with Mongolian conglomerates looking to develop resources and infrastructure. Sovereign-wealth funds such as Singapore's Temasek Holdings Pte. Ltd. and China Investment Corp. also have shown interest.

Temasek and private-equity firm Hopu Investment Management Co. in late 2007 invested a combined $300 million in Hong Kong Lung Ming Investment Holdings Ltd., a firm that owns a majority stake in the operator of Mongolia's Eruu Gol iron-ore project.

CIC is also in talks to invest $300 million in Lung Ming, people familiar with the situation have said.

Ivanhoe's chief executive said last month that several sovereign funds had expressed interest in investing in the company.

Global banks including Credit Suisse Group /zigman2/quotes/202835784/composite CS -0.23% and Deutsche Bank /zigman2/quotes/203042512/composite DB -0.09% AG have provided development financing for resources companies such as Mongolia Energy Corp., Lung Ming and South Gobi Energy Resources.

Resource firms are also seizing opportunities. Australian construction company Leighton Holdings started a mining contract at Ukhaakhudag Coal Mine in southern Mongolia for Energy Resources LLC.

With Mongolia, investors now have a "really good opportunity of getting exposure to the mining sector and also to get into the China resource play," said Mandar Jayawant , who is heading up Frontier Investment & Development Partners' Mongolia fund out of Ulaanbaatar. Frontier is raising what it believes is the first-ever Mongolia-focused private-equity fund. Frontier expects its first closing with $45 million from Korean and Japanese investors early next year and aims to raise $100 million.

"It is certainly almost impossible to exaggerate Oyu Tolgoi's multiplier effect," Christopher Wood , an analyst at CLSA Asia Pacific Markets wrote in a recent report. "Mongolia has the potential to become the ultimate high-beta play for the investment story based on China's rapacious demand for resources."

Next up is Tavan Tolgoi, a six billion-ton coal deposit, where potential investors include Brazil's Vale /zigman2/quotes/204339679/composite VALE +3.01% , Peabody Energy /zigman2/quotes/203600175/composite BTU +9.46% Corp. and Chinese companies.

But as in other frontier markets, the country's legal system is a source of concern. And though Mongolia has major mining deposits, private-equity firms can't easily invest large sums in them.

Write to Ellen Sheng at ellen.sheng@dowjones.com

Corrections & Amplifications
A previous version of this article incorrectly referred to a deal for Ivanhoe Mines Ltd. to develop the Oyu Tolgoi copper-and-gold deposit as Mongolia's first mining privatization. The Mongolian Government issued mining licences for the deposits at Oyu Tolgoi to Ivanhoe Mines in 2003 and their development has been paid for solely by Ivanhoe Mines, without the use of state funds.

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