An overall view of the the Ger district as it continues to expand on October 22, 2012 in Ulaanbataar, Mongolia. The Ger district is growing as many of the new city dwellers are in need of affordable housing, after coming to the capital city for employment. (Paula Bronstein/Getty Images)

Outside, it’s minus 22 degrees as a February wind blasts across the Central Asian steppe and through the Mongolian capital, Ulaanbaatar. Inside Government House, President Tsakhia Elbegdorj delivers a televised speech that simultaneously warms his people and chills foreign investors.

The country’s 76 legislators have convened to debate the future of one of the planet’s richest copper and gold mines, Oyu Tolgoi, which is 66 percent owned by the London-based Rio Tinto Group and 34 percent owned by the state. Elbegdorj tells them Rio Tinto has let the project’s total cost balloon by $10 billion. The higher expenses, which Rio Tinto disputes, would diminish and delay profits the government shares in.

“The time has come for the Mongolian government to take Oyu Tolgoi matters into its own hands,” Elbegdorj says to cheers from the lawmakers. His demands include giving Mongolian employees more management positions on the project, which is scheduled to begin exporting copper concentrate by June.

Few things matter more in the political and economic life of this landlocked country of 2.8 million people than foreign investment to develop its mineral wealth. Mining money has spawned gleaming office towers, pricey gated communities and luxury-car dealerships in the capital. And yet, half of all Mongolians still live like their nomadic ancestors in circular felt yurts.

Minegolia, to use a nickname that’s become more common during the mining boom, remains a poor country. About 30 percent of the population lived in poverty in 2011, according to the government, although that was an improvement from 40 percent in 2010, before the start of payouts funded by mine proceeds.

Puntsag Tsagaan, the president’s chief of staff, says he doesn’t want to see his country turned into Minegolia. Mineral wealth should be exploited cautiously and benefit the people, he says: “It does not have to be unlocked in a generation.”

Mongolia’s gross domestic product expanded 12.3 percent last year to $10 billion. Economists expect 15 percent growth this year. Oyu Tolgoi, which means Turquoise Hill, will be the largest contributor to the economy once it’s fully operational. With fees, royalties and the government stake, as much as 71 percent of profits will go to Mongolians, the International Monetary Fund estimates.

“There is scope for Mongolia to vastly develop if it gets everything right,” says Vidur Jain, a strategist at Monet Capital, an investment bank based in Ulaanbaatar.

At the moment, much appears to be going wrong. Instead of basking in new mineral riches, Elbegdorj is sparring with Rio Tinto. In addition to the complaint about a cost blowout, the government says the company should have paid taxes last year and needs greater financial transparency.

In his speech to parliament on Feb. 1, Elbegdorj wasn’t just bluffing. A few days later, his government briefly froze Rio Tinto’s bank accounts.

“I’m concerned by recent political signals within Mongolia calling into question some aspects of the investment agreement,” Sam Walsh, Rio Tinto’s chief executive, said in a webcast. “This undermines the partnership we’ve built.”

Rio Tinto, through its Oyu Tolgoi unit, says it has prepaid taxes and wasn’t obligated to make payments in 2012. The company says Phase 1 construction costs are on budget, at $6.2 billion, and in line with estimates it gave the government in December 2010. “We have always been fully transparent with all our shareholders regarding our project finances, costs and operations,” Oyu Tolgoi chief executive Cameron McRae said in a statement.

Until recently, Oyu Tolgoi had billboards in the capital that touted the IMF estimate that most of the mine’s profits will benefit Mongolians, illustrating the point with a loaf of bread cut into two unequal pieces.

After two decades of laissez faire, the government last year introduced regulations and laws to rein in foreign investors. These include insisting that a foreign company acquiring more than a 33 percent stake in a mine or other strategic industry get approval from a government agency. Investments above 49 percent must be approved by parliament. The government has more than Rio Tinto in its sights. St. Louis-based Peabody Energy, London-based Anglo American and several smaller mining companies also operate in the country.

“There’s a real doubt in the minds of Mongolians about foreign investment,” says Mark Mobius, executive chairman of Templeton Emerging Markets Group, whose $1.5 billion Templeton Frontier Markets Fund returned 24 percent last year. His fund has only 1 percent of its money in Mongolia. “It’s very low on the totem pole,” he says.

Some investors who have made Mongolia a priority may be heading for the exits, says Travis Hamilton, managing director of Singapore-based Khan Investment Management, which owns stakes in Mongolian companies. “Without legislative clarity, clear leadership and a welcoming environment for investment, the government risks a flight of capital,” he says.

Even the U.S. ambassador to Mongolia has joined the fray, chiding the government and investors for their hostility to one another. “The lack of respect is killing projects,” Piper Campbell told delegates at a mining conference in Ulaanbaatar. “I have been in meetings with the government and businesses where both sides accuse the other of violating laws, acting corruptly and other lapses — without thought of the impact of those kind of attacks. Both sides leave the room angry, the disputes fester, and when disaster inevitably comes, everybody acts surprised.”

Mongolia may already be paying a price for its toughening stand. After jumping 139 percent in 2010 and 47 percent in 2011, the tiny Mongolian Stock Exchange’s Top 20 Index tumbled 19 percent last year. It has fallen 15 percent this year, shrinking its market capitalization to $545 million as of April 8.

For Alisher Ali, founder of Silk Road Finance, an Ulaanbaatar-based investor in frontier markets, that’s a buying opportunity. He says he’s increasing his stakes in companies such as APU JSC, a beverage maker based in Mongolia.

“This period of underperformance is short-term,” says Ali, who also invests in Burma and Mozambique. “Ultimately, the Oyu Tolgoi issue will be resolved because it is in the long-term interests of both Rio Tinto and the government.”

For many Mongolians, national pride may count for more than investment dollars. Eight centuries ago, Mongol rulers were the world’s most powerful men. Genghis Khan’s empire stretched from the Mediterranean to Korea. His grandson Kublai Khan declared himself emperor of China, ruling from a fabled summer palace at Xanadu.

Elbegdorj, 50, himself a former nomad whose travels eventually took him to Harvard University, heads a mere fragment of that once-mighty realm. Surrounded by China and Russia, Mongolia has been dominated by one or the other of its giant neighbors for most of the past 300 years.

The country was an impoverished satellite of the former Soviet Union during much of the past century. It still retains the Cyrillic alphabet, and many of Ulaanbaatar’s 1.3 million inhabitants live in crumbling concrete apartment buildings from the Soviet era. Others live just outside the city’s center in yurts — known locally as gers — without sewers, running water or, in most cases, electricity. Smoke from their coal fires has turned the capital into one of the world’s most polluted cities, according to a World Bank report.

With the Soviet empire crumbling in 1990, Mongolia emerged as a turbulent democracy with revolving-door governments. Because the country is a minerals exporter, its proximity to China has been a coveted asset. Oyu Tolgoi is 60 miles from the Chinese border. To best exploit that geographic advantage, though, Mongolia must upgrade its dirt roads, threadbare rail network and overloaded power grid.

Last year, it issued $1.5 billion of Chinggis bonds, named for the local spelling of Genghis, and the government plans to sell an additional $3.5 billion.

Rather than simply letting investors mine ore and ship it across the nearest border, the government plans facilities such as a copper smelter, a coal coking plant, an oil refinery and an iron pellet plant that will add value.

Mongolia is displaying newfound confidence internationally. In 2003, it sent 120 soldiers to support U.S. troops in Baghdad — a city the Mongol hordes sacked in 1258. It has small peacekeeping missions in Afghanistan and South Sudan. For now, though, Elbegdorj is consumed by domestic politics. A presidential election is due in June, and he’s betting that playing hardball with mining companies will be a vote winner.

He may be right. Out in the Gobi Desert, near where Rio Tinto’s miners are digging for copper in shafts 4,300 feet underground, Aimtan Ulam-Badrakh, 54, stands stoically beside his isolated yurt watching his 300 sheep and 10 camels graze on tufts of brown grass.

At first glance, it’s a way of life unchanged since the days of Genghis Khan. Step inside the yurt, however, and a different story unfolds. The stocky herdsman can afford a leather couch, a television and a computer. An iPhone 4 lies on a bed — one of three mobile devices his family shares. His wife works part time at the airport built for the miners. His daughter teaches English at a local school, having learned the language while on a scholarship in Malaysia sponsored by Rio Tinto’s local unit. Along with other desert dwellers, the family has been further enriched by as much as $11,000 in compensation paid by the mining company for the disruption its project has caused.

Ulam-Badrakh says that he is glad Oyu Tolgoi is being developed but that he also has reservations. “Foreigners cannot just dig up the land, take away our wealth and leave us with a big hole in the ground,” he says. “It has to be beneficial for foreigners and the Mongolian people.”

The full version of this Bloomberg Markets article appears in the magazine’s May issue.