Fat Prophets take profits

In our last review of Meridian Gold (NYSE:MDG) back in August (FAT77), we were very upbeat regarding this emerging gold and silver producer. A rising unhedged production profile and exciting exploration prospects was in our view an ideal combination in light of robust precious metal prices. Not surprisingly, the shine on Meridian attracted the attention of a suitor in the form of Yamana Gold.

"In our view, the offer is fair in the sense that it brings forward value we are confident Meridian would have generated as a standalone operation in time."

Yamana's original interest in Meridian formally got off the ground back in June, however two more revised offers were required before Meridian agreed to the takeover conditions. We believe the offer is fair in the sense that it brings forward value Meridian would have generated as a standalone operation in time.

That however is not the full story. From our perspective two aspects of the deal lead us to conclude that capital could be better allocated in opportunities elsewhere.

The first is the company's transition from a gold and silver producer (with zinc by-product) to a precious metals and base metals miner. Whilst we are strong believers in diversification in all of our miners, this particular split is not ideal.

With our gold miners, we prefer our diversification to be regional. Thus we have miners typically with multiple gold mines in various geographies. This reduces the risk of political interference or adverse weather conditions that can impact mine performance.

Meanwhile, miners such as BHP Billiton or Rio Tinto (see today's report) are diversified across one or more different industrial commodities. Granted there is some exposure to gold through these miners, however the focus is on other output such as iron ore, copper or nickel.

In fact, Members may recall that Anglo American, another Fat Prophets recommendation, is in the process of selling off AngloGold Ashanti in order to 'unlock' the value of this pure gold play.

The terms of this takeover will result in Meridian combining with Yamana, also a copper producer, and Northern Orion, another gold and copper producer. We believe this is a sub-optimal mix and would prefer a more focused exposure to gold.

The three way tie up also leads to our second concern. Integration of two companies is usually enough to deflect management attention, however a combination of three is likely to make significant demands due to non-mining aspects of operations.

We believe this would be an unwanted distraction in mature operators, however given the early stage of production these companies are currently in, we believe performance is likely to suffer unduly as a result.

In our view this will lead to under performance within the sector. And we should raise the very important point that we still have a very positive view of the natural resource sector. However, we want to be positioning Members to be in those companies we believe are operating near the top. By doing so we get the benefits of making the correct sector call plus company specific out performance.

Recent mergers in the gold industry indicate to us that this is unlikely to be the case with Meridian, Yamana and Northern Orion, due to integration issues distracting management at such a critical time in their collective development.

For the record, the deal for shareholders is C$7.00 and 2.235 Yamana shares for each Meridian share. (The cash component will be converted to USD as at the second offer acceptance date of 2 November according to Meridian.) Having surpassed the minimum purchase condition of the offer, Meridian's stock price now reflects this valuation.

Gold will remain one of the cornerstones to the Fat Prophets portfolio. Backing our bullishness for the yellow metal are the compelling fundamentals, in our view. The current economic climate has made fertile conditions for the accumulation of gold as a store of value. Meanwhile years of under investment in the past now mean that gold mine production is in decline despite the fact that prices are at 27 year highs.

Accordingly, we firmly believe that gold will eclipse $1,000 per ounce before the end of the current bull market. In fact, we would not be surprised to find ourselves re-evaluating this target higher in the next twelve months.

However, the takeover of Meridian allows us to opportunistically lock in some future gains today. Given our view that integration and the introduction of base metals to the equation will hamper performance, we believe now is a prudent time to take substantial profits on this recommendation.

As such, Fat Prophets recommend selling MDG around $38.35. In the weeks ahead we will be aiming to recommend another alternative, more pure precious metal miner as a replacement in the portfolio.