Companies need to take a ‘granular’ view of Mexico

A report by the Eurasia Group says the government of Mexico will remain ineffective in its fight against crime.

The political risk analysis and consulting group notes that homicides in Mexico in August rose 24% year-on-year to 1,938, while extortions were up 22%, and kidnappings climbed 31% — “underlying a deterioration of the country’s security conditions.”

The Eurasia report stated that “violence continues to escalate nationwide, as conflict persists among various drug cartels. Spending cuts at the ministries in charge of security will probably further hinder the fight against crime.”

The New York-headquartered group also warns that violence will remain a serious issue for the rest of President Enrique Pena Nieto’s administration.

Neil Brown — a principal with KKR, a global investment fund founded by Henry Kravis, George Roberts and Jerry Kohlberg in 1976, which as of June 30 managed $131 billion — told The Northern Miner in an email that while he remains bullish on investing in Mexico across sectors, investors “also have to take a granular look at the local level to assess the security situation.”

Mexican federal police officers at the funeral of an officer killed in the line of duty in Ciudad Juarez in 2011, allegedly by members of a drug gang. Photo by Vic Hinterlang.

He said that “most of the country doesn’t pose especially aggravated security concerns, but other areas are much more difficult. In those areas, investors have to seriously consider operating costs of securing a facility and personnel, along with risk of failure, before making an investment.”

During a panel discussion on Mexico at the inaugural Mines and Money Americas conference in Toronto, Brown noted that KKR looked hard at Mexico three years ago, trying to assess investing across sectors.

What KKR found, he told the conference, were attributes that included positive demographics, a strong consumer base, responsible fiscal and monetary policy — even when lower oil prices hit the economy — a fantastic global trade position, excellent cost of labour (“beating China when it comes to industry labor costs”) and a manufacturing sector “going through the roof — which is important for mining when you think about the supply chain involved.”

He also praised more than a dozen constitutional reforms by President Pena aimed at increasing the country’s productivity, among other things, and pointed to success stories like Monterrey, the heart of industrial Mexico, “which is doing fantastically well,” and to Tijuana, which is “also a great success story.”

Earlier this year, he said, KKR completed a transaction of over US$1 billion with Pemex, Mexico’s state oil company, “so we’re ready to go in Mexico, and we hope to do more.”

Brown cautioned, however, that it’s not all positive. “We have to be realistic about the challenges around corruption, around security, and what those lead to, which are some real questions on governability,” he said. “The reality is that Mexico is going in a bad direction on security right now.”

Most of the violence is related to drug cartels, he said, “so it’s fairly contained, although there have been pretty spectacular examples of that not being the case.”

Brown noted that the cartel violence is geographically concentrated, once again emphasizing that investors need to take a granular view, and drew a hypothetical Canadian comparison to make his point: “You can’t have some kind of bad event in Calgary and decide you can’t invest in Toronto.”

Nevertheless, he said, “the government needs to improve.”

“There are too many localities that are simply overpowered by the local cartels,” he conceded. “These are not gangs. These are sophisticated multinational cartels that deal not only in drugs, but also in fine art, and all sorts of other things that hold value.

“You have to have a holistic approach” to the problem, he added. “It’s not enough to throw police at the situation. You also have to reform the prisons. You have to reform the judiciary.”

Mining executives Akiba Leisman, chairman and CEO of Marlin Gold Mining (TSXV: MLN), and Tony Rovira, managing director of Azure Minerals (ASX: AZS), were also participants on the Mines and Money panel and weighed in on Mexico’s strengths and weaknesses.

Marlin owns the La Trinidad gold mine, 110 km southeast of Mazatlan, which went into production in November 2014. The company holds royalties on two Mexican projects, Kootenay Silver’s (TSXV: KTN) La Cigarra, in Chihuahua state in north-central Mexico, and Endeavour Silver’s (TSX: EDR; NYSE: EXK) El Compas, a fully permitted gold-silver mine, 1 km south of the city of Zacatecas.

Azure is progressing two advanced-stage precious and base metal projects with two of the world’s major mining companies — its flagship Alacran silver-gold-copper project, with Teck Resources (TSX: TCK.B; NYSE: TCK), 50 km south of Mexico’s border with the U.S., and Promontorio, a copper-gold-silver project with Rio Tinto (NYSE: RIO) in Chihuahua state.

On the topic of security, Azure’s Rovira said that in the 10 years he has worked in Mexico the company has never had an incident with any of its personnel. “Maybe that’s good luck or maybe it’s good management, and good planning,” he said. “But I have to say, we have guys working in a bunch of different areas and to go for 10 years without an incident shows that Mexico has a positive side, as well. So yes, bad things can happen, but also a lot of good things, too.”

Rovira added that the company and its employees try to make themselves visible. Azure Minerals’ trucks have the company’s name written across the doors, and employees wear company badges as a preventive measure. Management also listens to its employees, virtually all of whom are local, Rovira says. “They know mostly where the safe places are and where the unsafe places are and, for example, we’ve been offered many different projects which geologically are incredibly attractive, but you say to your geologist, ‘would you like to go and work there’ and he says, ‘no, thank you very much,’ and so we know it’s not a place we want to go and frequent.”

Beyond that, he notes, there are basic rules: “You don’t drive at night, you don’t drive alone and you always have someone with you.”

Weisman of Marlin Gold, who is the only non-Mexican at the company at any level, admits that in 2012, when the company acquired its La Trinidad project, “we were a bit naive of what the situation was in Mexico.

“We took a view to basically run our mine with our heads down, so we never had armed security at the site. Initially we thought that was a good idea, and then when things got worse in Mexico, because they have been getting worse over the last 12 to 18 months, that became untenable.”

Now the company has taken a more serious approach to the local security situation and has armed security guards on-site.

But Weisman pointed out that the professional cartels “have no interest in interfering with mining companies.”

He says that “frankly, they have more lucrative things to worry about than the precious metal mining space.”

Like Azure Minerals, Marlin also makes sure that deliveries to the mine are made with company logos on the vehicles. “They have been accosted a lot less, interfered with a lot less, when people know that it is a Marlin truck that is going in to deliver goods to the mine and as long as it is understood, we actually haven’t had too much in the way of interference in the way of any criminal organizations,” Weisman says.

He notes that developing the La Trinidad project in Mexico was much easier than developing Marlin’s silver-gold project in Arizona. Both La Trinidad and its development-stage asset in the U.S. delineated their resources around the same time.

“There’s a reason why one is a mine and one is a development-stage project,” he says. “There are a lot of good things about having projects in the U.S., there’s certainly an element of security and an understanding of what the rules of the game are, but I can’t think of a single jurisdiction where we were able to go into a pre-permitted project in 2012, get it permitted, get it built and get it into commercial production as quickly as we did in Mexico.”