Rising costs of production and exploration have put a serious damper on many companies in the mining sector.   

It is difficult to emphasize just how much the world has changed for the miners in the last eighteen months. Things that were being contemplated are now obsolete, shelved or reversed. It's rare to see such a rapid shift.

But's it's happening all around the world. Last month, overall costs for Ouy Tolgoi, one of the world's largest copper-gold-silver projects, ballooned to $13.2 billion, up from an already hefty $9.5 billion before.   

Australia's mining costs have skyrocketed even higher. Australian coal, for example, has been the country's most valuable export for decades. But rising wages and the strong Australian dollar now make coal twice as expensive to produce as it was in 2006.

BHP Billiton this month said it would shut its Norwich Park metallurgical-coal mine after the joint venture with Japan's Mitsubishi Corp. racked up sustained losses. Xstrata PLC shut three Australian mines last year because costs rose too high as reserves became depleted.

It's not just Australia.  

Costs in Mexico have also gone up. Baja Mining Corp said costs at its copper-cobalt-zinc project in Mexico have shot up, expecting the spending on the Boleo project to go up 21.5 percent from 2010 estimates.

All around the world, costs are rising. What once was profitable is profitable no more.

The result has left many producers and explorers with little room for growth. Perhaps that's why the sector is suffering.

But amidst extreme rising costs, there are great projects that not only make sense, but continue to prove it's a money maker no matter what is being thrown at it.   

Still One of the Best

On Thursday morning, MAG Silver (TSX: MAG) (NYSE.A: MVG), one of my favourite silver explorers and a company in my portfolio (see The Most Important Silver Project in the World), released a very important updated Preliminary Economic Assessment (U-PEA) on one of the world's best undeveloped silver projects.

Despite rising costs, the report clearly shows that MAG Silver's (MAG) flagship Juanicipio project (44% interest) remains one of the world's highest grade and most economical undeveloped silver projects on the planet.   

Juanicipio is considered to be one of the richest silver discoveries in recent history, hosting an astounding indicated resource of 6.2 million tonnes with an astounding average grade of 728 grams/t silver, 1.9 g/t gold, 1.9% lead, 3.9% zinc (containing 146 million ounces of silver) and an inferred resource of 7.1 million tonnes with an average grade of 373 g/t silver, 1.6 g/t gold, 1.5% lead, and 2.6% zinc (containing 85 million ounces of silver).

The U-PEA already has analysts buzzing:

"One of the top precious metal discoveries of the cycle...Robust economics make Juanicipio a stand-out project...We continue to recommend MAG Silver with an Outperform rating and target price of C$15.50." - Michael Gray, Macquarie Capital Markets Canada Ltd.

"World Class. The PEA outlines a stand-alone underground operation with, in our view, excellent economics. The PEA further de-risks Juanicipio and economics remain excellent; we continue to view the project as one of the premier undeveloped assets in the silver space." - David Sadowski, Raymond James

"In our opinion, the updated PEA demonstrates that the Juanicipio project remains one of the most robust silver projects on the planet...With the PEA completed, the JV can now move forward with permitting, likely to begin construction in 2013. We continue to view MAG Silver as a likely acquisition target in the junior silver space." - Nicholas Campbell, Canaccord Genuity

Carried out by AMC Mining Consultants, the U-PEA defines the Juanicipio Project as an economically robust, high-grade underground silver project exhibiting minimal financial or development risks that will produce an average of 15.1 million payable ounces of silver over the first full six years of commercial production and 10.3 million payable ounces per year over a 14.8 year total mine life.

Despite generally being conservative with their numbers, AMC's judgement on the project remains extremely positive defining a robust project with a base case IRR (internal rate of return) of 54% pre-tax and 43% after-tax revenue. Pre-tax Net Present Value ("NPV") at a 5% discount rate is $1.762 Billion and after-tax NPV at a 5% discount rate of $1.233 billion.

Under the study and net of by-product credits, it will cost literally nothing to produce 10.3 million ounces of silver a year for nearly 15 years - despite a major increase in costs over the last few years. The study shows a negative cost of ($0.03) to produce each ounce of silver. As MAG owns a 44% interest, its share will be 4.5 million ounces of silver every year for 15 years at no cost. Keep in mind that these numbers are discounted by 5% using 3-year trailing metal prices.   

If you do the math using current prices, the economics of the project become mindboggling. The grades are so high that, unlike the majority of silver projects around the world, the Juanicipio project is quite insensitive to fluctuations in silver prices and rising costs. That makes the project bullet proof in many ways. Even if silver prices were to drop by more than 65% - say to around $10 an ounce - the project would still remain highly economic.   

A few weeks ago, I sat down with MAG's CEO Dan MacInnis and had a talk about how grade affects projects around the world - given that rising costs have shut down many mines and projects around the world. Here's a brief excerpt from that discussion:

"Usually when metal prices are going up, costs are going up along with it. Just because you have high metal prices, your operating costs eat all that up. (Sometimes) you need metal prices to double, just to catch up with a 10-15% increase in operating costs.   

I was reading an article in the Globe and Mail where Tye Burt at Kinross talked about increasing costs. He said that a year and a half ago, a spot price for a new tire for one of his 250 tonne trucks was $40,000. Today, it's $100,000 for the same tire. That's more than double the costs in 18 months and that's what's going on right now.

So when you look at some of these other companies that have put together $1 to 1.5 billion build ups that's a year and a half old, there's probably been a 20-25% increase in materials, costs, and everything else. If you got a billion dollar capex, that's another 200 million you have to come up with - in only 18 months. It's very daunting.   

...If I was in that position, I would look at shrinking the deposit and going after the high grade portions of it and pay it back. There's no substitute for grade. Focus on the grade and it will take care of everything that you need to do." - Dan MacInnis, MAG Silver CEO May 19, 2012

The extremely high grades found at Juanicipio are a testament to what Dan and I talked about. Dan is right: If you focus on the grade, everything will take care of itself.    

And MAG's Juanicipio is a perfect example. 

Under the U-PEA, costs have grown to reflect rising prices. Estimates for the initial capex on Juanicipio is now $80 million higher than in the 2009 PEA study and sustaining capex have risen dramatically to $267 million - up from analyst estimates of $60-80 million a few years back.   

This major rise in cost has already destroyed many of the undeveloped silver projects around the world and is already hurting many silver producers. But it has barely scratched MAG. Even with the high rise in costs and a substantial rise in sustaining capex, Juanicipio continues to be highly economic. In fact, for every $1 silver goes up, another ~$100 million in pre-tax NPV is added to the project.

Here are some highlights from U-PEA¹:

• Pre-tax Net Present Value ("NPV") at a 5% discount rate of $1.762 Billion and an Internal Rate of Return ("IRR") of 54%;
• After-tax NPV at a 5% discount rate of $1.233 billion and IRR of 43%;
• Payback of 3 years after plant start-up;
• Initial capital cost ("CAPEX") of $302 million over a 3.5 year (42 months) pre-development period;
• Sustaining Capital of $267 million over life of mine;
• A 14.8 year mine life from mining and processing 13.3 million tonnes, averaging 416 grams per tonne ("g/t") silver, 1.3 g/t gold, 1.4% lead and 2.7% zinc;
• Life-of-Mine ("LOM") payable production of 153 million ounces silver, 430,000 ounces gold, 361 million pounds lead and 584 million pounds zinc from the production of lead, zinc and pyrite concentrates;
• Annual payable silver production averages 10.3 million ounces at a total cash cost of (negative) ($0.03) per ounce silver, net of by-product credits (MAG's 44% annual share of payable silver ounces is 4.5 million ounces);
• For the first full six years of commercial production, payable silver production averages 15.1 million ounces per year at a cash cost of $0.27 per ounce silver, net of by-product credits (MAG's 44% annual share is 6.6 million ounces) and;
• The AMC Study does not take into account any potential mining, processing or infrastructure synergies from any association with the adjoining property owned by Fresnillo.

¹The AMC Base Case utilizes a discount rate of 5% and three year trailing average metal prices for silver ($23.39 per ounce), gold ($1,257 per ounce), lead ($0.95 per pound) and zinc ($0.91 per pound) to December 31, 2011.

You can find the full news release by CLICKING HERE.

The U-PEA for MAG's Juanicipio project clearly demonstrates to the world that it can't be hurt by rising costs. No matter what the study threw at it, the results came back strong. 

There is no question whether or not Juanicpio is one of the highest grade and most robust silver projects on the planet.   

The only question is when and how its going into production.   

What Next?

The other 56% of the Juanicipio belongs to the world's largest primary silver producer, Fresnillo. The project sits right in the middle of their backyard.

Both MAG and Fresnillo were originally slated to meet on June 26, 2012 to review and discuss the next steps for the project. However, this has been pushed back slightly so that both parties can review the study more closely. In my view, that just means Fresnillo needs more time to devise a strategy on how they can take MAG out.   

It's clear Fresnillo does not want to see any more added value given to MAG. They want MAG - they just don't want to pay the price...yet. Even in Fresnillo's news release, it's clear to me that they are doing whatever they can to downplay the significance of the U-PEA:

"While the results of the AMC study are promising, as anticipated by us, it constitutes a preliminary study that, by definition, is preliminary in nature and, among other things, includes inferred mineral resources that are considered too speculative geologically to have the economic considerations applied to them that would enable them to be categorized as mineral reserves. The estimates produced in the study have a level of accuracy in the order of +/- 25%. There can therefore be no certainty that the results reflected in the AMC Study will be realised. It is also important to note that mineral resources that are not mineral reserves do not have demonstrated economic viability.   

Fresnillo intends to complete a full review of the study and the recommendations made by AMC. The Technical Committee of the Joint Venture, which comprises Fresnillo and MAG Silver representatives, will then discuss and evaluate the implications of the AMC study and recommend to the Board the appropriate next steps. As Fresnillo has previously said, the AMC study was prepared on the basis that the Juanicipio project will be developed on a standalone basis. There are no plans to integrate the project with any of Fresnillo's properties in the area."

I am sure MAG's management knows that Fresnillo will want little attention for the U-PEA. It's pretty obvious by now that Fresnillo doesn't want to pay too much and their recent news release proves it.  

Why wouldn't Fresnillo include the existing infrastructure in the U-PEA? If MAG and Fresnillo put this thing into production under a stand-alone scenario, it would take 3.5 years - and it would be plain stupid. If they used Fresnillo's existing infrastructure, the shaft and mill that is less than 1km away, it could be producing in less than two years - maybe less.   

MAG's management knows Fresnillo wants to downplay the numbers. That's why MAG also contracted Snowden, another mining consulting agency, to fact-check AMC's U-PEA and both consulting agencies came up with very similar numbers.   

With the completion of the AMC Study, MAG and Fresnillo now have a framework on which the joint venture Technical Committee can build upon for the continued advancement of the Juanicipio Project. I think that something will happen very soon between the two parties...   

Let's not forget that drilling continues and that means there remains outstanding exploration upside to expand the resources at Juanicipio. This would only add more value to the already robust project. 

Before it's Too Late

With rumours and hints that QE is not only required, but imminent, silver and gold prices will only climb.

(This past week also saw one of Britain's last great independent financial markets sold to China: The Londons Metal Exchange (LME).

The deal will pull together the LME which accounts for 80 per cent of the world's base-metal options and futures contracts with China, which accounts for 42 per cent of the world's metal consumption.

This will undoubtedly open up an even bigger market into China's wealth for trades into other metals. While its not precious metals, I believe this is a giant step for China to flex their muscles on a global financial platform.)  

There's no doubt that precious metals prices will rise. Three to five years from now, gold prices could be above $3000/ounce and silver prices easily above $50/ounce. I bet on it.   

If MAG's updated PEA was based on current prices, it would be an absolute monster.  

I've seen a lot of undeveloped silver projects...MAG's Juanicipio is by far one of the best.

Ivan Lo

Equedia Weekly  

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Are You Brave Enough to Buy Low?         

By Louis James   

This time last week, I was at the Cambridge House World Resource Investment Conference in Vancouver, BC. Usually the show is quite hopping, but this time, while there was the usual mob and there was standing room only at several of the events Doug, the Casey crew, and I participated in, the mood was decidedly low-key.

But here's the interesting part: it was low-key, but not depressed.

In fact, with metals and related stocks having just had a particularly vicious few months in the markets, I was half-expecting an angry confrontation with a soon to be ex-subscriber... maybe more. But that didn't happen. People were quietly coming up to me and asking, "So, what are you buying?"

I subsequently heard from one subscriber who had followed our published advice to average down and after the June-first surge in gold, was overall in the black. This is no mean feat during a bearish turn of the market, but not really surprising when someone buys value when it's on sale.

Back at the show, I polled my workshop audience, as I often do. This was almost the last session of the last day of the conference. From out over the show floor, I could hear the sounds of the company promoters tearing down their booths. And yet, the hall filled to capacity, and there were people standing in the hallway outside by the end of my presentation. These were serious investors.

When I asked them how many were worried about gold's recent negative price movements, I was not surprised that only a handful put their hands up. When I asked them how many were excited by the opportunity, about three times as many put their hands up. That means most were unsure what to think, which is always the case, but I was pleased to see that there was a significant presence of people at the show who viewed the low energy level as a buying signal.

People brave enough to buy when others are not interested know the secret of how to "buy low and sell high" - they are true contrarians.

I know such people exist. I work with them every day here at Casey Research. But it's precisely because such investors are rare that contrarian investing is possible.

Quick reminder: to be a contrarian does not simply mean to do the opposite of what everyone else is doing. There can be wisdom in crowds - in a way, a market price is a distillation of mass judgment. And a broken clock can be right twice a day. No; it's not just about being ornery. A contrarian is a person who analyzes markets, finds trends she or he regards as very solid - solid enough to put financial weight on - and invests accordingly regardless of what others think, say, or do.

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