A Word of Caution Before Buying Silver Wheaton
Douglas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
There is no question that Silver Wheaton Corp. (NYSE: SLW) is a favorite amongst precious metals investors and analysts. The company has one of the strongest business models in the space, is extremely well run and controls the largest silver reserve on the planet. With the company about to go ex-dividend on Aug. 28, there will be an even greater buzz pushing individuals to jump into the stock and cash in on the company’s solid dividend policy. Silver Wheaton is a great company by almost any standard, but this may not be the best time to initiate a position if one does not already own the stock.
Silver Wheaton’s Business Model
Unlike Pan American Silver Corp. (NASDAQ: PAAS), Silver Wheaton is not a silver miner. This is an important distinction to make because it means that many of the pressures that face Pan American are not concerns for Silver Wheaton. Much that is written about Silver Wheaton assumes that it is a miner and thus may include false conclusions. Pan American faces the very real challenges of mining operations, including dealing with cleanup costs after the useful life of a mine has been exhausted. These costs are becoming a growing concern for miners and should not be overlooked. The company just went ex-dividend on Aug. 22.
Silver Wheaton is a silver streaming company, meaning that rather than actually mining, it contracts with others to buy their production at a fixed, predetermined price. In many cases, the company is able to negotiate these contracts without the need to outlay any upfront capital into the project. This places a significant downside protection on its exposure to any given contract or mine. Currently, Silver Wheaton owns the rights to roughly 800 million ounces of silver reserves at an average cost of just above $4. This means that the company earns the spread between the current price of silver and its cost. If silver prices climb, the company has the potential to deliver a magnified return.
Silver and Gold
Over the past three months, the returns available from silver and gold have been very similar. Using the iShares Silver Trust (NYSEMKT: SLV) as a proxy for silver and the SPDR Gold Trust (NYSEMKT: GLD) as a proxy for gold, silver has actually outperformed, up by 9.74% relative to 7.25% as of the close on Aug. 24. To keep this in perspective, the Market Vectors Gold Miners ETF (NYSEMKT: GDX) is up 7.89%. During the period, gold and gold mining companies have lagged the price appreciation of silver. This illustrates an important feature of silver, particularly heading into the next round of quantitative easing by the Federal Reserve. The price of silver tends to be more volatile than the price of gold because silver is a drastically smaller market. Moves in silver tend, therefore, to be larger. If precious metals are set to go on a run, courtesy of the Fed or other global macroeconomic influences, the returns in silver may be larger.
Now that Word of Caution
Over the past month, the price of Silver Wheaton’s stock has significantly outperformed the price of SLV; the stock is up 25.11% relative to appreciation by SLV of 11.3%. Over the past three months, Silver Wheaton is up 29.5% relative to a rise of 9.75% for SLV. Despite the reality that the price action of Silver Wheaton tends to amplify the price action in the price of silver, this degree of outperformance should give the prudent investor a moment of pause.
Silver Wheaton is an outstanding company that should be a part of every commodity portfolio, but entry at these levels may carry an undue level of risk. While there is a reasonable argument to be made that if one misses the run that QE3 is likely to cause, one will have left significant profits on the table, it is worth considering before making an allocation. If the price of silver marches steadily higher from here, there will not be an issue. If, however, there are further dips, much more attractive entry points may present themselves.
Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.