Can Silver Wheaton Protect You From Sequestration?

In what is becoming a mundanely American story, the White House and Democrats are locked in another power struggle with congressional Republicans over the sequestration cuts that are set to take effect on Friday in the absence of political action. While the market has genuflected this way or that ahead of the automatic cuts that the Congressional Budget Office (CBO) estimates will result in the loss of 1.4 million jobs, Wall Street and even Main Street have yawned, paying little attention. What else does one do when the naughty children have been told time after time to behave? You run out of breath, stop being surprised, and, to some extent, assume that self-interest will rule the day.

In this case, self-interest means another eleventh-hour deal that just saves the day and permits another series of equally yawn-inducing sound bites. Please do not mistake my dismissive tone as a lack of concern, but one does become anesthetized at some level. There are two possibilities as we head into Friday: Congress will act or it will fail to act. Fortunately for investors in Silver Wheaton (NYSE: SLW  ) , either case can be seen as positive in its own way.

Sequestration explained
According to recent polls, there remains a high level of confusion over the very nature of sequestration. It refers to a series of automatic spending cuts that was conceived as a way to cajole Congress into making cuts with bipartisan support. The idea was that under the threat of much larger cuts, lawmakers would find a way to find a middle ground and agree to more measured ones. The fact that these cuts are looming on the horizon should tell you that the plan was not successful.

The nature of the cuts can be made very generic or much more human, depending on the tactic you prefer to adopt. Over the next decade, $500 billion would be cut from the Department of Defense budget, and 1000 federal law enforcement agents could fall out of the budget. FEMA could see its budget shrink by $1 billion and 31,000 teachers may lose their jobs. Ultimately it is these job losses that will have the most significant effect on the economy and on the precious metals markets.

As things currently stand, the White House is in the middle of another game of chicken with congressional Republicans. The market has not reacted much to the prospect of the cuts largely because even after the economy went over the fiscal cliff, Congress just wrote a back-dated check and apologized. The sense seems to be that some version of this will happen again.

If the sequester happens
Starting with the less likely case, if the sequestration cuts are allowed to go into effect, precious metals will soar. The impact will be heightened in part because nobody on Wall Street is expecting this. If this eventuality does occur, a mass flight to the safety of precious metals will take place. Arguably, the sequestration cuts could trigger a serious recession, making the iShares Silver Trust (NYSEMKT: SLV  ) a better choice.

A recession would place competing pressures on Silver Wheaton. On the one hand, silver, including the company's roughly 800 million ounces of reserves, will instantly become far more valuable. On the other hand, Silver Wheaton is a participant in the economy and will face the same pressures as the rest of us. Recessionary pressures on the company would likely be outweighed by the surge in the price of silver, but the stock could well lag the commodity under this type of scenario.

Furthermore, if the CBO is correct about the loss of jobs, any hope of the Fed easing up on the printing press will be lost. Regardless of your view of the current inflation expectations, if money keeps getting pumped into the economy, inflation will occur. This is also a positive for the stock.

If a last minute deal occurs
In the likely event that a last minute extension is granted, allowing Congress to kick the can down the road again, Silver Wheaton will still benefit. Short of an actual agreement between the parties, which is all but a practical impossibility at this point, the government is continuing to lose credibility. This weakens the economy and makes precious metals more attractive. Furthermore, just because a rash of job loses does not occur, Silver Wheaton is still benefiting from the Fed's current course of quantitative easing. Despite the rumbling of growing dissension at the Federal Open Market Committee, Chairman Bernanke is still running the show and the printing presses have not slowed.

The takeaway is that the year-to-date weakness in the stock presents a solid buying opportunity for Silver Wheaton shares. The stock is well-positioned at current levels and has a strong medium-to-long-term outlook.

If you want to dig even deeper into a company whose success is determined by the metals market, but without involving itself in the risks of physically mining the metals, then Silver Wheaton provides a unique play on the future of silver. SLW chooses to finance the mining of silver; it 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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