Silver Wheaton and the Coming Storm

While the fiscal cliff was avoided in the strictest sense, many of the issues involved heading into the year are far from resolved. Sequestration cuts were delayed, not cancelled, and the debt ceiling is still looming large on the horizon . While the details of the war are different, Congress and the White House are drawing the same battle lines and taking the same stances that technically led us over the fiscal cliff -- a backdated deal was the saving grace . Against this backdrop, the economy finds itself in the same jeopardy that it was a few short weeks ago. Credible estimates suggest that the government will run out of money on February 15 . In this environment, Silver Wheaton (NYSE: SLW  ) remains one of the best ways to protect your portfolio.

The same old song and dance
If you thought Congress was going to learn a valuable lesson from the experience of the near-miss with the fiscal cliff, you would be both in good company and totally wrong. The situation again requires satirical humor, as best explained by Stephen Colbert: "It's like Congress put a gun to the economy's head and swore it will pull the trigger if Congress doesn't put its own gun down." This is how he explained the fiscal cliff and this is how we can understand the debt ceiling.

Yesterday, Jay Carney, White House press secretary, said, "There are only two options to deal with the debt limit. Congress can pay its bills or it can fail to act and put the nation into default." In exchange for agreeing to another increase to the debt limit, congressional Republicans have insisted on significant spending cuts . The White House vehemently contends that it will not negotiate.

Carney further stated: ""The president and the American people won't tolerate congressional Republicans holding the American economy hostage again simply so they can force disastrous cuts to Medicare and other programs the middle class depend on while protecting the wealthy. Congress needs to do its job." Regardless of your political affiliation, it seems fairly clear that the "job" of Congress is to find a balance between paying for the things we want and funding the things we need. A refusal by either side to compromise is irresponsible, in my opinion.

The political ramifications of doing nothing need to become quickly greater than the ramifications of flinching first. If they don't, we may all find out what happens when the world's largest economy plays chicken with the world's largest egos. My guess is it won't be pretty.

What does this have to do with silver?
Just as the fiscal cliff was expected to plunge the economy in a new recession , if the politicians in Washington manage to shut down the government, the result will be similar. If a recession does hit, commodities, particularly precious metals, should continue their multiyear rally. As the chart below illustrates -- using the SPDR Gold Trust (NYSEMKT: GLD  ) as a proxy for gold and the iShares Silver Trust (NYSEMKT: SLV  ) as a proxy for silver -- both precious metals have performed well for an extended period, although silver has been more volatile. Commodities are widely considered to be an excellent store of wealth and weak economic conditions should bode well.

GLD Chart

GLD data by YCharts.

On the other side of this argument is the industrial demand that may be created from a period of economic expansion. As fellow Fools Dan Caplinger and Sean Williams point out, the continuing demand for high-tech devices that utilize silver should continue to put upward pressure on silver prices. Silver Wheaton, largely as a result of its superior business model, is highly leveraged to the price of the commodity.

Unlike competitors such as Pan American Silver (NASDAQ: PAAS  ) and First Majestic (NYSE: AG  ) , Silver Wheaton is not purely a miner but a silver streaming company. Where its peers face increasing environmental concerns, soaring operating costs, and stricter regulations, Silver Wheaton is largely immune from these forces. It contracts with other miners to buy the silver production of those companies at a predetermined and fixed cost. Silver Wheaton then earns the spread between the contract cost and the prevailing market price.

During 2013, the company continued to expand its reach through a new contract with Hudbay Minerals (NYSE: HBM  ) . Under the new streaming contract, Silver Wheaton provided $750 million in a multistaged financing in exchange for the silver production of the 777 and Constancia  mines for the life of each. Silver Wheaton also gained rights to the gold production of the 777 mine through 2016. It is arrangements like these that have allowed the company to achieve an average silver cost around $4 per ounce.

Given the uncertainty in the economy and the fact that the company appears poised to perform under a variety of scenarios, the stock, in my opinion, is a buy at current levels. It is trading off of its 52-week high, a return to which would represent a nearly 14% return, and it looks like there is plenty of upside remaining in the name. Silver Wheaton belongs in your core portfolio.


 

This company continues to provide a unique play on the future of silver. Silver Wheaton has grown sales and net income every year since 2008, and also has increased competitive advantages over its limited peer group. More details about our outlook for Silver Wheaton can be found here in our Motley Fool analyst report.



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  • Report this Comment On January 15, 2013, at 7:39 PM, TempoAllegro wrote:

    Silver Wheaton is certainly on my short list of companies to include in my long-term portfolio. I have a few points to add for the consideration of readers.

    Most of the argument contained within the article, in my opinion, is short to medium-term stuff that will likely affect gold as much or more than silver right now. The "stuff" I am talking about is that precarious dance between Congress and the Fed - walking a high wire balancing act of monetary and fiscal policy - with fiscal cliff, debt ceiling, and the various QE programs that amount to endless printing of American currency. Sooner or later this will push up the price of precious metals up. This is just one of four main arguments for PMs to go up.

    In a nutshell, we got 1) central governments printing money, 2) modern industrial uses of these metals, such as silver being used in electronics, 3) rising demand for precious metals in increasingly wealthy countries like India and China while global production over the last 20 or so years has not actually increased, and 4) increasing willingness of central banks to hoard gold and precious metals because they, in effect, view PM's as an alternative or default currency. Put another way, if there is even an outside chance that my national currency could fail through hyperinflation, then I want a ready supply of a basket of other currencies on hand and that is likely to include at least some PMs.

    So, long term, silver is the smart bet because there are more and more modern uses, and the stuff is gone after it comes out of the ground and gets used up by industry. It is also below its historical price ratio in relation to gold.

    I would not, however, go so far as to say avoiding mining companies completely is correct. Sure, they have to deal with regulations and labor issues, but they also own the hard assets and get any unexpected positive benefits from the mining operations. After Silver Wheaton makes its agreement, that's it, no further upside possible beyond that. And then, if those regulations or conditions for the miners get tough - don't be so naive as to think Silver Wheaton will escape negative effects just because it is not getting its hands dirty in the mines. Next time they have to make a deal, it is going to be much harder for them to get the same good terms they had before. And you know how Wall Street reacts when expectations are not met.

    And if you like the streaming business model, and you agree with the points made in the article - why not consider SAND, which is a gold-streaming company using the same model as Silver Wheaton? I like SLW better, but am considering SAND as well.

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