The perils of mining

The surprise announcement last Wednesday that Agnico-Eagle (TSX, NYSE: AEM) has shut down operations at its Goldex mine in Val d’Or, Quebec reminds us just how risky the mining business can be — not just for the miners but for investors as well.

The company said the closure was necessitated by weak volcanic rock above the ore deposit which allowed water to flow into the mine. The situation is being investigated further and it is uncertain whether the mine will ever be able to reopen.

The stock plunged by 18.5 per cent, more than $10 a share, after the news came out and took another hit the next day. The deep sell-off may have been something of an over-reaction. Goldex, while an excellent producer, isn’t the only mine in the company’s inventory. The company has three other operating mines in Canada, one in Finland, and one in Mexico. However, the rush to dump AEM shares is indicative of the market’s uneasiness at present.

Goldex had an estimated 1.6 million ounces of proven and probable gold reserves. It was expected to produce 184,000 ounces this year at an estimated cash cost of $349/ounce. That made it one of the lowest-cost underground mines in the industry. Now the company has decided to write off the total value of the mine (US$170 million) in its third-quarter financial report, which is due out on Oct. 26. All the reserves will be reclassified as mineral resources, which are assigned a much lower value when assessing a company’s net worth. The cost to AEM for on-going monitoring and remediation is estimated at C$45 million over the rest of this year and in 2012.

The Goldex mine was Agnico-Eagle’s second-largest producer — the open pit Meadowbank mine in Nunavut is number one. In 2010, Goldex produced 184,386 ounces of gold out of the company’s total of 987,609 ounces. That was 18.7 per cent of the total which coincidentally (or not) was almost the exact amount the stock lost in value after the announcement.

This wasn’t the first blow to Agnico-Eagle’s production this year. A fire at Meadowbank in March destroyed the kitchen facilities, resulting in the need to temporarily cut back the work force and reduce production.

Despite the loss of Goldex, RBC Capital Markets expects AEM to increase year-over-year production in 2011 as well as in 2012 and 2013 thanks to higher contributions from the remaining properties. Output this year is expected to be 1,024,000 ounces according to analyst Haytham Hodaly and associate Jason Billan. That will increase to an estimated 1,093,000 ounces in 2012 and 1,185,000 ounces in 2013. If the numbers pan out, the 2013 production would be almost 20 per cent higher than in 2010 — and this assumes no contribution from Goldex.

RBC has lowered its target price on the stock to $71 (from $94). That is 60 per cent above the current level which suggests AEM is a buy for patient investors who can tolerate risk.

Risk is the critical word when it comes to any mining stock. Even the biggest and brightest can be hammered by unforeseen developments. Consider the case of Cameco (TSX: CCO, NYSE: CCJ), the world’s largest uranium producer. The share price was clobbered in the aftermath of the March nuclear disaster in Japan which led to countries such as Germany declaring a moratorium on new atomic power plants. But Cameco’s troubles began long before that.

The company owns a 50 per cent interest in the Cigar Lake mine in the Athabasca Basin of Saskatchewan. It holds the world’s largest undeveloped uranium reserves — 209.3 million pounds at an average grade of 17 per cent. Unfortunately, the deposit is deep (480 metres down) and is located in a very unstable area which is comprised primarily of highly porous sandstone.

Construction on the mine began in 2005 with the expectation of a start-up in early 2008. But in April and October 2006, the mine was completely flooded after a rock fall, setting back work for years. Cameco has spent millions to drain and seal the mine, clean up the silt and debris, and re-start construction. Initial production is now scheduled for mid-2013 but given the star-crossed history of this venture, nothing should be taken for granted even though the company says Cigar Lake is a key component in its plan to double total production by 2018.

Floods and rock falls aren’t the only problems facing mining companies. Strikes, political unrest, falling commodity prices, currency fluctuations, and environmental issues are only a few of the many other setbacks they can experience. So every mining stock should be seen as high risk, no matter how big the company. If you can’t handle that, stick to utilities.

This article originally appeared in the Internet Wealth Builder, a weekly e-mail newsletter that provides timely financial advice from some of Canada’s top money experts. For more information about becoming an Internet Wealth Builder member, go here.

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