A gleaming opportunity

At Fat Prophets, we are constantly on the look out for opportunities to gain new exposure to sectors we hold in high regard. And as sectors go, gold mining ranks right at the top. This is due to our long held bullish view of the precious metal. Last week's stock market turmoil has provided, somewhat surprisingly, another chance to add a high quality mid-tier producer.

Surprising because in times of uncertainty, gold as an asset class should out perform given its traditional safe haven status. This did not occur however as gold prices retreated from recent highs. Explanations for selling gold included the need to fund margin calls and covering losses in equities.

We believe these may be valid reasons for the decline, however in a prolonged period of market volatility we expect gold to rise to the top. Other supporting factors also remain in place. These include reduced central bank sales, foreign reserve diversification into gold, solid jewelry demand, de-hedging by producers, declining global mining production and a weaker greenback.

So all in all, our long held positive outlook for gold remains unchanged. In time, we believe the precious metal will resume its long-term upward trend and extend to new highs above last May's high of $730.40. To gain exposure to this increase in price, we are recommending Meridian Gold (NYSE, MDG) for the first time.

We believe that Meridian possesses a great combination of current production and reserves, low costs and solid exploration potential. Last year Meridian's turnover increased a healthy 38 percent to $240 million. Higher industry wide cost inflation however held earnings down to $48.8 million, a 22 percent increase on 2005. We anticipate 2007 results will far exceed these due to new production and expansion coming on-line.

Before going any further, some background on where it all started for Meridian. Back in 1972, the company which we know today as Meridian Gold was a minerals division within FMC Corp, a diversified chemical company. Whilst exploring in Nevada, team geologists found rock samples containing gold and silver. The find became Meridian's first grassroots gold discovery and in time produced more than five million ounces of gold.

By 1987, the FMC geologists had made two additional grassroots discoveries. It was also the year FMC chose to spin-off the subsidiary as FMC Gold. The new company also acquired earn-in rights in the Rossi gold project which remains today as a 40 percent interest.

In the early 1990s, FMC Gold bought Meridian Gold Company and began exploring in Chile and Mexico, to good effect. By the end of 1993 the company made its fifth discovery, the El Penon deposit in Chile - today's flagship mine. It was not until 1996 however that the company changed its name to Meridian Gold, Inc.

As the 90s drew to a close, El Penon had its first gold pour, resulting in the company's first full year of profitability a year later in 2000. Filling out Meridian's current operations are the Esquel project in Argentina (acquired in 2002) and the Minera Florida mine in Chile, purchased last year for $100 million.

Although a mid-tier gold producer now, back in 2003 Fortune magazine recognized Meridian as one of America's 100 Fastest Growing Small Companies. The stock price has obviously reflected this growth. Meridian has been in a firm upward trend for most of the past decade. In this time, the price of the stock has risen more than twenty-fold, achieving an all-time high of $38.31 in May.

During the past 10 months, Meridian's stock price has entered a consolidation phase, in line with the gold price. Despite recent volatility, we do not view the break in upward momentum as a threat to the longer-term trend.

As shown on the daily chart, the correction during the past two weeks has found trendline support at $24.35. We believe this area will continue to limit downside risks in the near term with additional support provided by the October low of $22.12.

Meridian's primary mine is El Penon located in Chile. Last year production at the mine declined to 230,145 ounces of gold from 303,509 the year before. The fall was primarily due to a decline in ore grade as a result of supplementing mill feed with stockpiled ore, while operations transitioned to new sectors of the mine.

We anticipate these issues will be resolved as Meridian completes both a plant expansion (first quarter) and mine expansion (third quarter). Supporting the improvements is a $35 million capital expenditure program. However, gold production for next year is still expected to remain in the 230,000 ounce range.

In addition to gold, El Penon produced nearly 6.5 million ounces of silver, a healthy 16 percent increase over 2005. This year the group is targeting a hefty 8.7 million ounces.

Elsewhere, the newly acquired Minera Florida mine chimed in with nearly 38,000 ounces of gold, 135,463 ounces of silver and 1,921 tons of zinc. While this output was welcome, the real boost to the bottom line will occur this year when production levels rise to 65,000 ounces of gold, 380,000 ounces of silver and 3,000 tons of zinc.

Other new gold production will be forthcoming from the Rossi joint venture (JV) with Barrick Gold. Meridian is expecting 25,000 ounces of gold when operations begin in the second quarter. The more anticipated event we are waiting for however is the updated resource model for the JV. Currently, resources sit at a lowly 241,000 ounces. We believe this will be the subject of a major upward revision once the resource audit process is complete.

Reinforcing Meridian's low cost credentials was a negative $22 net cash cost of production per gold ounce using the 'by product' method. However, even when abandoning this methodology, the cash cost is still a healthy $175 per ounce of gold equivalent. We believe these low costs, combined with rising gold prices, bode very well for future profitability.

At the group level Proven and Probable mineral reserves stand at 2.3 million ounces of gold, 83.7 million ounces of silver and 31.3 tons of zinc. Upgrades to these figures should result as the company continues to pursue an active exploration program. This year alone, Meridian is planning to spend $26 million on its organic growth strategy.

Besides the Rossi JV upgrade, Meridian has over 3.5 million ounces currently classified as Measured and Indicated at the Esquel project in Argentina. In 2005, the company wrote off the value of the project due to the suspension of activities in the face of local opposition. Whilst legislation prohibits mining in the region until 2009, we believe the resource will eventually be upgraded into reserves and developed into production. Clearly, this is more of a longer-term project.

Nearer-term, Meridian is pursuing opportunities at the Mercedes project in Mexico, Jeronimo in Chile and Natividad in Nicaragua. These all possess exciting upside potential.

According to management, Mercedes could become Meridian's next operational mine. Spread over 70,000 hectares, Meridian will drill over 20,000 meters this year in an effort to extend known veins.

Estimates at Jeronimo, a joint venture with CODELCO, are for 2.8 million ounces of gold resource. This year's exploration program is targeting 22,000 meters of drilling in addition to the start of metallurgical work.

Meanwhile, Natividad is a huge project covering 283,247 hectares. Thus far promising drilling results have confirmed bonanza grade strikes. Further drilling will be used to develop a feasibility study which is a condition of Meridian's earn-in.

From a balance sheet perspective, Meridian remains strong. With nil debt, cash and long-term investments have decreased from $282 million last year to $215 million, however this takes into account $120 million in acquisitions (Minera Florida and Jeronimo). .

Given the backdrop of a positive outlook for gold combined with the strength of the long-term upward trend in Meridian, we believe the stock will move higher in the months ahead. A clear break above the February high of $31.68 will trigger further gains in our opinion, targeting a retest of the $38.31 all-time high.

Considering the potential for future gains, we believe the recent correction in price provides a good buying opportunity. Accordingly, we recommend Meridian Gold to all Members around $25.40.