Agnico-Eagles Mines

The History of Gold

On April 30, 2002, shares of Agnico-Eagle Mines Ltd. (AEM) of Toronto, Ontario, a Canadian gold  producer with more than 30 years of precious metals mining experience, had just closed at US$13.89  on the New York Stock Exchange, a decline of nearly a dollar from the previous day. Dan Acker, a  senior portfolio manager at National Securities Inc. (National) of Toronto, Ontario, reclined in  his office chair, stared at his computer monitor and contemplated the red numbers beside AEM's  ticker symbol. He was in his fourth year of managing one of the largest Canadian equity portfolios for National.  Acker, whose portfolio had a substantial number of AEM shares, had considerable interest in the  future of the company. AEM had been one of his portfolio's strongest performers over the past four  months and Acker had become accustomed to seeing daily gains from the company. With such a large  one day sell-off, he and his investment team at National wondered whether the price decline was a harbinger of further declines. Acker couldn't afford to give back the gains he had made 
year-to-date. He wondered to himself, should National be selling? Acker and his team of MBA graduates.

Michel Nickols and Bill Chelonis, had recently spent time at  AEM's LaRonde mine and believed in the operational potential of the company. National's research department had prepared free cash flow forecasts for AEM, which, following their visit with the  company, Acker had reviewed and modified to the team's satisfaction. Acker knew that despite his team's belief in the future prospects of AEM, the stock may have become overvalued from a  fundamental viewpoint. Acker asked his team to perform a fundamental valuation of the equity of AEM.

Since primitive time, gold has been accepted as a universal means of exchange. Gold evolved from  being part of an individual ruler's treasury, to being part of the reserves of a nation, typically  held by its central bank. The gold standard, which became the dominant monetary arrangement in the  world, beginning in 1880, collapsed in 1914.² It was reinstated as a gold exchange standard between  1925 and 1931. After the Second World War, the 1944 Bretton Woods agreement set a legitimate  standard for all major western countries. Under this agreement, countries undertook to maintain a  fixed value for their currencies against the U.S. dollar, while the dollar itself was pegged to  gold at US$35 per ounce.

Global Mining Industry

This peg came under pressure in the late 1960s and was ultimately  abandoned in 1971." The price of gold rose rapidly during the 1970s after the link was finally abandoned, reaching a price of more than US$850 per ounce in 1980. Following that all-time high price, the average price of gold decreased to US$277.90 per ounce by the end of 2001.

As of 1999, South Africa, the United States and Australia were the world's largest gold producers.  In 1999, Canada ranked fifth in gold production, producing 5.1 million troy ounces out of a total  of 81.0 million ounces.? In 2000, India was by far the world's largest consumer of gold, buying  more than 27.5 million ounces.

Companies in the mining industry were generally divided into three categories based on the size of  their yearly production. There were senior gold producers, such as North American Barrick Gold,  Newmont Mining and Placer Dome; and South African seniors, such as Anglogold and Gold Field  Limited. Each of these companies produced more than one million ounces of gold per year. Senior  producers actively acquired junior gold companies to ensure continued production. Junior gold  companies concentrated on locating, investigating and developing early stage exploration projects. 
These companies produced less than a hundred thousand ounces of gold each per year.

Canada was one of the world's most attractive mining countries. The Fraser Institute ranked Canadian provinces and countries around the world based on their gold mining investment  attractiveness. In 2001/02, Quebec and Ontario tied for first position, while Australia, Chile and  Brazil rounded out the top five.

Gold companies in general and Canadian companies in particular had endured a tough period since the fall of gold prices started in the early 1980s. Few gold companies had generated positive net  income in the years from 1998 to 2001 (see Exhibit 2). Return on equity (ROE) in the intermediate  mining sector had largely been negative. A total of eight Canadian gold mines had closed or  suspended operations in the past two years in response to either the depressed gold prices or ore  exhaustion.

However, industry prospects had started to look brighter (see 2001 figures in Exhibit 2) manifested in a 19.5 per cent increase in equity prices over the last three months, with AEM up  40.7 per cent year-to-date (see Exhibit 3).

Mining gold yielded a number of by-products, such as zinc, copper and silver. Generally speaking,  the depth of the production shaft determined the type and purity of the extracted minerals  as  mining depth increased, the grade of gold extracted increased. The sale of the by-products was  subtracted from the cost of production, thereby reducing the cost of goods sold. Over the past 20  years, the price of zinc had appreciated, whereas copper and silver had seen significant declines.

Mining companies generally recognized revenue on a production basis. Under this basis of  accounting, revenue was recognized after the ore was extracted and processed at the on-site mill facility.