Yamana Gold: This Hand Demands to be Played

| About: Yamana Gold (AUY)

Yamana Gold (NYSE:AUY) is a mid-tier gold mining exploration and production company, focusing on South America. Their primary assets are located in Brazil and Argentina. They are targeting 2007 production of ~600,000 oz of gold with a target of 1 million oz by 2009. Significant copper by-product credits allow them to mine gold at negative cost

Accumulation Range: $12 or better (for a 25-40% margin of safety)

Intrinsic Value Range: $16-$20

The Skinny

In Texas hold 'em poker, my least favorite hand is a pair of queens. It's one of those hands where I've got to play it strong but I'm sweating the whole time. Any ace or king worries me and if the opponent shows strength, I've got to wonder about folding.

In a report on Agnico-Eagle (NYSE:AEM), I dubbed Yamana the "Cramer-anointed gold stock", which is a back-handed way of saying the stock had a good amount of hype behind it. AUY, along with the other gold miners, took a dive. Then they announced the deal with Northern Orion (NTO) and Meridian (MDG). The market punished them, holding down AUY even while stocks like IAMGold (NYSE:IAG) and Agnico-Eagle have climbed. This leads us to our "pocket queens" analogy and the way I see it, the hand demands to be played.

Yamana is a quality gold miner with sizable current production. They are coming into their mature phase with positive cash flow and earnings. The proposed merger has hung a cloud over the stock, making it available at a good price. It's not our favorite gold mining stock - i.e. it's not 2 aces, but two queens aren't bad and the downside is low-risk and low-impact. If the merger doesn't go through, then Yamana is the same company it was before the announced merger. This is the same one that John Doody of Gold Stock Analyst proclaimed a top-ten stock projected to double within two years (he put a sell on it when the deal was announced). Yes, Peter Marrone is an action junkie but we already knew that.

It's hard to see this deal actually happening. Meridian has already announced their opposition to it and given the open hostility rained upon Marrone on the conference call, I hope he thinks twice about raising the offer. NTO shareholders didn't sound pleased by the proceedings either.

If the deal closes at the announced price, new Yamana is worth a little less in our eyes but still has upside to its current price. The new company would have attractive assets and be drowning in cash flow. According to Marrone, they used a baseline copper price of $1.50/lb in running the numbers so there's quite a bit of wiggle room (current copper ~ $3.50/lb).

If Yamana raises their offer, the stock's already got the bad news priced in and shouldn't dovetail too much. We wait for the bounce and exit at the next opportune moment.

Certainty Rating: B+.

Gold mining stocks are extremely volatile. Even so, the current economic and monetary policies all but assure a depreciation of the US dollar. Barring a global market meltdown, Yamana will shake off the hangover from this deal and we should see a nice bounce as the gold/dollar story slowly plays out. If there is a global market correction, there won't be many places to hide, safe haven or not.

It's important to come into this investment with eyes wide open. Yamana is an operationally competent company with a tendency to dilute shares. But that is Marrone's style; any investment in Yamana must acknowledge and accept that aspect of their strategy.

My biggest concern is a raised bid price for Meridian. But other than that or massive operational setbacks (always a possibility), Yamana offers good upside with low risk of capital loss. Just remember to buckle your seat belt on any gold investment.

Disclosure: Author has a position in AUY