Many precious metals equity investors have exposure to Peru through companies like Newmont, Pan American Silver, and Southwestern Resources, yet most don't know much about Peru. In this report, we share our findings on Peru, as well as our first hand experience from a recent visit to a property in the country.

Peru: Politics and Mining:

Peru is a country with an abundance of geological resources and promising economic conditions. In 2005, the country boasted its best real GDP growth rate in eight years, growing 6.7%. Inflation, which was a serious problem for the country in the 1980s has been at OECD levels since 1999 and looks poised to remain at such levels in the future.

This mixture of strong economic growth and low rates of inflation has enabled the government to strengthen and develop local capital markets, reduce external debt, and build up reserves; all while running record current account surpluses. Peru is an economy on the rise.

	2002	2003	2004
GDP ($US)	56,490	60,577	63,650
REAL GDP (%CHG)	4.9	3.8	5.1
FISCAL BALANCE (%GDP)	-2.3	-1.8	-1.4
INFLATION RATE	0.19	2.26	3.48
EXCHANGE RATE AVE (S/./US$)	3.5	3.5	3.4
EXPORTS (MILLIONS OF US$)	7,723	8,986	12,547
MINING EXPORTS	3,734	4,597	6,881
OTHER EXPORTS	3,988	4,388	5,667
IMPORTS (MILLIONS OF US$)	7,417	8,255	9,818
CURRENT ACCOUNT BALANCE (MILLIONS OF US$)	306	731	2,729
Sources: Central Reserve Bank of Peru and Ministry of Economy and Finance of Peru, 2005

Much of Peru's current economic success can be attributed to the country's geologic wealth. Both within Latin America and on a world scale, Peru is a leader in the production of commodities such as: gold, copper, silver, tin, zinc, lead, and moly.

How important is mining to the Peruvian economy? Fifteen percent of the foreign direct investment that enters Peru can be directly attributed to mining. Since the 1990s mining (including refining and smelting) has accounted for about 11% of Peru's GDP, over 45% of the economy's total exports, and contributed about 13% of the government's tax revenues.

	2002	2003	2004
Total	7,723	8,986	12,547
Mining Sector	3,809	4,597	6,881
Gold	1,501	2,045	2,362
Copper	1,187	1,261	2,446
Zinc	429	529	577
Lead	211	201	398
Silver	174	191	260
Iron	83	94	129
Tin	155	175	299
Other Metals	69	102	410
Other Sectors	3,914	4,389	5,667

Copper, gold, silver, zinc, iron ore, and tin are the main metals produced in Peru; altogether they account for about 95% of the country's mineral exports.

Many of the world's largest mining companies have major stakes in Peru including: BHP-Billiton, Newmont, Phelps Dodge, Teck-Cominco, and Barrick. These companies are not primarily attracted to Peru in the hopes of discovering and developing high-grade deposits. Rather, the main asset that Peru has for mining companies is its wealth of large, low-grade deposits; many of which have yet to be discovered or exploited. These deposits can be mined at a discount to other regions. For example, at Newmont's Yanacocha gold project in Northern Peru production costs are believed to be as low as US$100 per ounce. This is significantly less than the production costs at Newmont's other operations in the United States (US$225/oz), Eastern Europe (US$225/oz ounce) and Indonesia (US$224/oz).

The mining industry in the 1980s:

If you looked at the Peruvian economy twenty years ago you would have seen a vastly different situation. In the 1980s the Peruvian economy was suffering from economic mismanagement. The economy was plagued by hyperinflation, the government was carrying a huge deficit, and the state had monopolized most of the country's mining operations. The mines controlled by the state were not receiving inflows of new investment and were reporting annual losses of around US$100 million. Production at the mines had stagnated and labour productivity was rapidly declining. The situation was bad.

Mining reforms in the 1990s:

At the start of the 1990s Peru had amassed a massive foreign debt. In a desperate attempt to attract foreign investment the government began to implement liberalization reforms. The goal of the reforms was to create stable and profitable conditions for foreign investment. Mining was a sector that was targeted directly by the reforms.

As part of the reforms, Peru enacted a privatization law in 1991. This led to the privatization of about 220 state-owned corporations, netting the government US$10.5 billon or about 17% of Peru's GDP. During the process most of the states mining assets were privatized. The last state owned mining operation was privatized in 2003, and only a few projects and concessions remain under state control.

In addition to the privatization program, since 1990 the government has created an attractive environment for new mining investments. Since the 1990s, foreign investors have viewed Peru as an attractive investment opportunity because the State has guaranteed property ownership, free remittance of profits, and capital repatriation. The Peruvian government has also cut subsidies and tariffs, freed foreign exchange and interests rates, liberalized international investment rules, simplified the tax code, and repaired its fiscal situation.

The impact that Peru's economic transformation has had on mining is astounding. From 1991 to 1997, mining concessions increased from 2,258,000 hectares to 15,597,000 hectares, or 700%. Over the same period metal mine production had an average annual growth rate of more than 8%. Between 1990 and 2000 mining exports more than doubled, rising from US$1.5 billion to US$3.2 billion. Over the period of 1992-2004, some US$1.9 billion of private investment capital was injected into the mineral sector for exploration, and about US$ 5.5 billion was invested for the establishment of new mines as well as for the expansion and enhancement of existing ones.

Mining Investment in Peru 1996-2004

Source: Central Reserve Bank of Peru

With the economic transformation of the 1990s largely completed and commodity prices soaring, Peru's economy is in excellent shape. Largely due to record mineral shipments, last year Peru's exports increased 37%. In addition, in 2005 the government posted its smallest deficit (0.4% of GDP) in eight years.

More than 100 foreign mining companies have established themselves in Peru since 1990. Whereas in the 1980s foreign mining companies were repelled from the country, now they have been welcomed with open arms.

The current political situation:

On April 9th an election was held in Peru. No candidate received more than 50% of the vote and a run-off vote will occur in May or early June. Ollanta Humala, a former army officer and leader of the nationalist party, will face Alan Garcia in the run-off.

Polls have suggested that when the run-off vote occurs, Garcia will win. Many of the people that supported Lourdes Flores, a right-wing candidate that placed 3rd in the April 9th vote, will place their support behind Garcia in the run-off vote. Although Flores' supporters have little love for Garcia, he is seen as the lesser of two evils when compared with Humala. In addition, the majority of the people that voted for the many splinter parties in the April 9th election will most likely place their support behind Garcia.

Alan Garcia is a well known political figure in Peru. In 1985, at the age of 36, he became the youngest President of Peru. His term lasted until 1990 and was marred by hyperinflation, social turmoil, human rights violations, increasing violence, power blackouts in Lima, and international financial isolation. Throughout his term the inflation rate rose from 87.7% in 1985 to astounding 7,649% in 1990. When he left office, the government was drained of its income sources and foreign reserves. This left the next government, lead by Alberto Fujimori, no choice but to seek the economic support of the International Monetary Fund, World Bank, and the international financial community.

In spite of his early political troubles, Garcia remains a popular public figure in Peru. He is known for his charisma, charm and oratory skills and has been referred to as "Latin America's best orator with a power to convice." Many of Garcia's supporters aknowledge that he made mistakes during his previous presidential term, but argue that he has valuable experience and solid new policies. They believe that he has matured and that he deserves a second chance. Garcia has also gained the support of younger voters who did not experience the disastrous effects of his previous presidency.

Garcia is a populist with a political outlook that steers a course between the extremes of raw capitalism and extreme nationalism. He is a moderate leftist that is not hostile to Washington. He has promised to reduce telephone and electricity rates, provide loans to farmers, maintain macroeconomic stability, promote workers rights, leavy a windfall profit tax on mining companies, and to oppose the ratification of the free trade agreement with the United States until a full public debate has occurred. He has also claimed that he is the only candidate that is prepared to represent the poor without a takeover of private property. Whereas Humala has gained the support of those in rural areas, and Flores gained the support of those in urban areas, Garcia's middle-left policies have allowed him to gain the support of a diverse voter base.

The other candidate, Ollanta Humala, is a retired Peruvian Lieutenant Colonel. During his military career, Humala was involved in the two major Peruvian conflicts of the past 20 years: the battle against the terrorist organization the Shining Path and the 1995 Cenepa War with Ecuador.

In 2005, Humala became the leader of the Peruvian Nationalist Party (PNP). For the current election campaign he is running under the Union for Peru (UPP) ticket, with the support of his own PNP party.

Humala has considerable support from the Peruvian populace outside of Lima. In particular he has a stronghold in Peru's second-largest city, Arequipa. He has maintained a strong nationalist, left wing stance that is popular with those that have remained impoverished and disenfranchised while the Peruvian economy has expanded over the last decade. Humala's supporters are fed up with recent political corruption and believe that Humala is "not of the corrupt bunch." Humala has also gained the support of those who believe he is a fearless warrior that has the ability to combat crime, discipline foreign corporations, and redress grievances against neighboring countries. Humala has stated his intentions to legalize the production of coca, renegotiate contracts with foreign mineral and hydrocarbon companies, end military co-operation with America, and void the recently negotiated free trade agreement with the United States until a referendum on the issue is conducted. He has also promised to improve health services, spend $3 billion on education, invest $1.5 billion in agriculture, and embrace economic regionalism.

Nonetheless, in meetings with business groups Humala has promised to respect private property, battle drug trafficking, and push for equitable trade pacts with the U.S and Europe.

Many people in the resource investment community have warned of dire consequences for mining companies if Humala wins the run-off in May. Humala has promised to create a nationalist economic policy, impose more taxes on mining operations, and assume state control over "strategic sectors." Humala, however, has not indicated exactly what sectors he means or how this is to be accomplished.

With mining accounting for more than half of Peru's export revenue and 13% of the government's tax base it has become an easy target for politicians that want to feed off the discontent of impoverished Peruvians. Throughout the election Humala has been strongly advocating economic nationalization in order to gain the support of the impoverished and disenfranchised. If elected, it is almost certain that his policies will be considerably tamer than what many people believe are his intensions now.

Humala may be spouting strong leftist discourse, but he is not going to return the economy to a situation like that of the 1980s. At most we can expect that his government would increase taxes or impose royalties on the mining industry. This would not have a drastic impact on the industry as Peru already imposes one of the lowest tax rates in Latin America - taxes paid in Peru represent 12.5 per cent of GNP, while other governments in the region demand, on average, 18 per cent of GNP. Although the potential election of Humala may spook the financial markets in the short term, in the long term his impact on the mining sector will be minimal.

Major mining companies with operations in Peru remain optimistic about the current political situation. Pete Faur, a spokesman for Phelps Dodge, is optimistic that the company would be able to work with whichever candidate wins. He was quoted as saying "we've always been able to find the common ground in the past." Even in the midst of political uncertainty the company is considering increasing its holdings in Peru through the purchase of BHP Billiton's Tinaya mine.

Raul Jacob, head of investor relations at Southern Copper, has remained confident that Garcia will defeat Humala in the run-off vote. Jacob's said, "we're watching the situation but, at present, we are not too worried."

Ultimately, mining in Peru will remain strong whomever is elected in the May run-off vote on June 4. In the worst case scenario, Humala will be elected, the financial markets may be spooked in the short term, and in the long term mining companies will be forced to pay higher taxes. Mining companies in Peru, which are currently under taxed according to Latin American standards and making boat loads of profits from increasing commodity prices will not find the increased taxes to be overly constraining. Calm will eventually return after the new administration takes office. Peru will continue to enjoy the abundance that has been provided by its mineral wealth.

Opportunities for Investment in Peru:

Currently the stocks of mining companies that operate in Peru are trading at a discount to those of other regions. Much of this discount can be explained by investor uncertainty about the country's political climate. We believe that after the June election, much of the uncertainty will be removed and alongside buoyant metal prices companies operating in Peru should reward their investors through share price appreciation

My Recent Trip To Peru:

I was recently invited by Acero-Martin Exploration (ASD.V) to visit their Pinaya gold-copper property in Peru. On May 1st the company released a drill hole of 83 meters of 2.1 gpt Gold and 1.11% copper. A detailed write up on the company's property can be found at http://www.maucapital.com/asd.pdf

May 3rd: I met up with Donald Gee CEO of Acero-Martin at the Vancouver airport, and got on a 6:30 am flight from Vancouver to LAX. After a 3-hour layover at LAX, we boarded LAN Airlines to Lima at 2pm. The plane was surprisingly empty with a final destination of Santiago, Chile.

May 4th: I arrived in Lima at 1am. A car picked us up at the airport and drove us to the Swisshotel for some much needed rest.

On the way to hotel, you couldn't help but notice the lack of investment in housing. Throughout the 30 min drive from the airport to the hotel there wasn't a 10-story high-rise building in sight.

I have long held the libertarian view that the government's role should be minimized to maintaining law and order. I believe there should be just two laws 1. Keep your word. 2. Don't infringe on others' property rights.

I got a taste for how such a system would work in Lima. Everywhere you look there are private armed security guards. I don't know if I would like to live in this environment.

Gambling is also prevalent in Lima. I must have counted over 20 Casinos both big and small in my travels throughout the city. In some stretches of the city Casinos seemed to be the only infrastructure developments. The problem with being a libertarian is the assumption that people are smart enough to take care of themselves. Well in this world of watered-down crowd intelligence, many can't think or manage to get by without handholding. My libertarian views as played out in Lima has resorted to armed guards for the rich and casino gambling for the rest. Mind you though Lima is not a representation of the rest of the country. In the countryside, the local Peruvians are very warm and friendly. I felt safe throughout the trip other than parts of Lima.

9am: We had breakfast with Alfonso Alvarez, Acero-Martin Exploration's legal council at the Swisshotel. Alfonso is a resident of Lima and looked to be in his late 50's and is very knowledgeable of Peru. He commented much on how Peru's stock market has flourished and how the country's trade surplus has improved recently. He was also optimistic of Garcia winning over Humala in the June 4 presidential election run off vote. Alfonso commented that Humala's parents openly called for the killing of all white people and gays. Under political pressure Humala has been forced to distance himself from his family.

The Peruvian middle class simply won't vote for Humala. In a country of 28 million, 8 million people live in Lima, and urban votes are extremely significant. Indeed the recent poll suggests Garcia is on track to become the next president.

Latest Poll last week had Garcia leading Humala by 14 points.

Comparing Peru to Bolivia is like comparing apples to oranges. Peru is 3 times larger in population (28 million vs. 9 million), 7 times larger in GDP (70 billion vs. 10 billion) and has a GDP per capital over twice that of Bolivia ($2,500 vs. $1,000).

11am: We went to a local Museum. It was interesting to learn that Peruvians lived for thousands of years without a written language until the Spanish came along in the 1500's.

left: streets of lima, some interesting color combinations
http://www.maucapital.com/peru/DSC00036.JPG
right: tour of a private Museum, notice they pay attention to details
http://www.maucapital.com/peru/DSC00039.JPG

left: pottery from the Museum.
http://www.maucapital.com/peru/DSC00041.JPG
right: garden of the museum. Donald Gee (CEO of ASD) and me on the right.
http://www.maucapital.com/peru/DSC00053.JPG

May 4th: 6pm, we boarded a LAN flight to Arequipa in southern Peru. Arequipa is Peru's second largest city and hosts around 2 million residents. We got into Arequipa at around 8pm and were shuttled to our hotel. Downtown Arequipa remains very much medieval with an absence of modern buildings. Being in the city almost felt like being in a Hollywood studio shooting a Wild West movie. We toured the city a bit, ate dinner, and went to bed.

May 5th: 7am, we got up for an early start, ate breakfast and got into three Toyota 4x4s that took us to Pinaya, Acero-Martin's main property. Total travel time from Arequipa to Pinaya was about 2 1/2 hours. The first two hours were on a well-paved road. Arequipa is about 2,000 meters above sea level (6,000 feet), while Pinaya is over 4,200 meters or about 13,000 feet. For your reference, Denver is at 6,000 feet and the top of Whistler mountain is 10,000 feet. I was starting to get uncomfortable at 3,000 meters.

left: a city view on the way to Pinaya from Arequipa.
http://www.maucapital.com/peru/DSC00055.JPG
right: 2 hours of well-paved highway from Arequipa
http://www.maucapital.com/peru/DSC00058.JPG

left: this is pretty much what we saw along the way
http://www.maucapital.com/peru/DSC00059.JPG
right: 30min to Pinaya
http://www.maucapital.com/peru/DSC00064.JPG

12pm: we arrived at the Pinaya camp. The doctor on site gave me some oxygen and I felt better. The weather was gorgeous and we picked the perfect time for the visit (May, which is fall for them). The camp hosts a cook, a doctor, several geologists and over two dozen or so local workers.

left: arrival Acero-Martin's camp
http://www.maucapital.com/peru/DSC00066.JPG
right: calcacite ($copper) core
http://www.maucapital.com/peru/DSC00070.JPG

left: alpaca at Pinaya
http://www.maucapital.com/peru/DSC00071.JPG
right: core sampling
http://www.maucapital.com/peru/DSC00072.JPG

You can see a lot of Alpacas from the Pinaya property. We must have seen around 10 herds each with 50 to 100 animals. We went by the Pinaya village, which is a few kilometers south east of main open pit. The village people of Pinaya used to own the Pinaya property and sold it Acero for about $750,000.

left: pinaya
http://www.maucapital.com/peru/DSC00074.JPG
right: pinaya village of 700 people, 20min from the property
http://www.maucapital.com/peru/DSC00075.JPG

I bought an Alpaca hat, table cloth, and a scarf for 60 Soles or USD 20 from the village store.

left: obligatory visit to the Pinaya store
http://www.maucapital.com/peru/DSC00077.JPG
right: Pinaya oxide pit
http://www.maucapital.com/peru/DSC00078.JPG

After the village visit, we did a property tour. The prospective footprint of the property extends several kilometers long. We drove around but by then I was sick as a dog from the altitude. As you watch the video clips (at the end of the report), I was starting to confuse north from the south.

left: tailings
http://www.maucapital.com/peru/DSC00079.JPG
right: drilling on hole 44
http://www.maucapital.com/peru/DSC00087.JPG

3pm: We said our goodbyes to the Pinaya crew and started heading back to Arequipa. High altitude has low pressure and thin air and I was developing common symptoms of altitude sickness such as shortness of breath and headaches. Overall, I felt like I had just gotten off a rollercoaster ride. See how the water bottle was squeezed upon arriving at Arequipa.

7pm: We had a relaxing dinner at an Italian restaurant next to a Monastery. I felt like I was in Italy. Still recovering from sickness, I went to bed early.

left: Physics 101 - Atmospheric pressure
http://www.maucapital.com/peru/DSC00089.JPG
right: Arequipa airport, country flare.
http://www.maucapital.com/peru/DSC00091.JPG

May 6th: 7am, we got up and left the hotel to catch a flight to Cusco to visit Machu Picchu. It turned out the plane we planned to catch to Cusco from Arequipa that was supposed to come from Lima was canceled due to fog. At 12pm we caught a flight back to Lima and the boarded another flight to Cusco from Lima. We got to Cusco around 5pm.

5pm. When we landed in Cusco, as a side trip for some shopping we got on a mini bus destined for Pisca. We got back to Cusco at around 8pm and had an excellent 3 course dinner for about USD $25 per person. Cusco has an European flare and is probably the most popular destination for tourists as it is the spring board to Machu Picchu (3 hours away)

left: Pisca, off Cusco
http://www.maucapital.com/peru/DSC00100.JPG
right: Machu Picchu
http://www.maucapital.com/peru/DSC00107.JPG

May 7th, 7am: We got an early start and took the bus and train to Machu Picchu. Machu Picchu is only about 2500 meters above sea level, but I was still recovering from Pinaya and a food bug I had caught. As you can see in the photo below, it was about 80 degrees F (20 degree C). People were wearing short sleeves, but I was disoriented and dressed like a winter bear. Machu Picchu is one of the seven wonders in the world. While I was impressed, I would like to put Machu Picchu in proper perspective.

1. It was built around 1500 AD in the Inca period; so Machu Picchu is only about 500 years old. This is a young site compared to Egypt's Pyramids.
2. In my view it's no secret that the locals built it instead of rumored aliens. All the surrounding mountains were rocky with pointed tops. The locals simply carved the stones on the top of the mountains to build the site.
3. It's not that big compared to the Great Wall of China. If I had been in good shape, I could finish touring Manchu Picchu in less than an hour.

All in all it was a good visit. For those who wish to visit, I would go early in the morning to avoid the tourist traffic, which was very heavily towards noon time. I just wish I hadn't been sick.

http://www.maucapital.com/peru/DSC00110.JPG
http://www.maucapital.com/peru/DSC00114.JPG

left: more Alpacas
http://www.maucapital.com/peru/DSC00117.JPG
right: all for USD 100 from Pisca, any one?
http://www.maucapital.com/peru/DSC00120.JPG

May 8th, we caught a morning flight back to Lima from Cusco and an evening flight home to Vancouver.

I like Peru. It's a friendly country with a GDP per capita that is 1/10th of Canada's and a lot of room for growth. With metal exports driving Peru's ballooning annual trade surplus (likely to top $5 billion in 2006 which would be outstanding for a $70 billion economy), I see Peru as a country that is moving forward. While I am not an expert in local politics, I think eventually the surplus wealth from mineral exports will benefit the local communities through infrastructure development such as housing, transportation, and communications. Ultimately, only time will answer the question, but I am in the optimistic camp.

Video Link 1 http://www.maucapital.com/asd1.mpg (approx 8min): my visit to Pinaya
Video Link 2 http://ww.maucapital.com/asd2.mpg (approx 7min): my visit to Machu Picchu

Disclosure: Acero-Martin Exploration Inc, by paying for my trip to Peru, sponsored this report. I own shares of the company. A detailed write up on the company can be found at http://www.maucapital.com/asd.pdf.