Has Silver Wheaton Peaked?

Douglas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Silver Wheaton (NYSE: SLW) has twice flirted with the $40-mark this year and twice failed to break it; the stock’s current 52-week high was reached nearly 52 weeks ago. Without venturing into a technical analysis of the stock and this potential resistance level, recent price action begs the question as to whether the company has peaked.

While the ultimate answer to this question is simple – Silver Wheaton is nowhere near its potential high moving forward – getting there requires a look at various global macroeconomic factors that are anything but simple.

The Inflation Picture

When the Federal Reserve announced its latest round of quantitative easing – to the extent that calling a policy of pumping $4 billion per month into the economy indefinitely a “round” makes sense – it set the economy of a collision course with real inflation. Rather than even pretending to balance between its dual mandate of controlling unemployment and inflation, the Fed has made clear that it will spend until the employment picture improves. The initial reaction of the market was positive, seeming to discount the longer-term inflation implications of the move, but this cannot last.

While it may be hard to predict exactly when inflationary pressures will overtake the bolstering effect of QE3, unless the employment picture rapidly improves, inflation will come. Given the fact that the first two rounds of QE pumped nearly $2 trillion into the economy while having no appreciable impact on employment, it is hard to imagine that the current course of action will be different. The current policy seems more targeted at changing expectations and beliefs than anything else – the "change perception instead of substance" approach. When the dust settles, inflation is coming and this is very bullish for precious metals.

General Weakness

The other global macro factor that is bullish for precious metals is the overall level of weakness in the global economy. As safe haven investment vehicles, precious metals remain attractive as long as the economy is struggling. As things currently stand, there are very few signs that any lasting recovery has occurred. While some numbers have firmed, there is a contingent of economists who believe another significant recession is on the horizon. Should this materialize, precious metals will become even more attractive.

Under the combined circumstances of inflation concerns and general economic weakness, silver is one of the best places to be invested because of the heightened volatility of silver relative to gold. While companies like Barrick Gold (NYSE: ABX) or ETFs like the SPDR Gold Shares (NYSEMKT: GLD) offer a solid option at current levels, their upside may be limited relative to Silver Wheaton. Some evidence can be seen by looking at the performance of these three stocks since the precious metal trade has come back into favor. Over the past three months, Silver Wheaton is up over 50% relative to 12-14.5% for the other two. Despite this outperformance, Silver Wheaton has additional upside.

<img src="http://media.ycharts.com/charts/2a2a54bdd1e17f5f0726d87a7b9a5557.png" />

SLW data by YCharts

Company-Specific News

As a silver streaming company, Silver Wheaton is not subject to the same costs that face most miners like Pan American Silver (NASDAQ: PAAS). This is one of the principle reasons that where Pan American has an operating margin of 36%, Silver Wheaton is able to achieve a 75% operating margin. The two companies face somewhat different pressures, so while Pan American is an attractive mining play, it does not have the same appeal as Silver Wheaton. The company contracts with other miners to buy their production at predetermined and fixed prices – this currently aggregates to roughly 800 million ounces of reserves at an average cost of $4.04.

When considering if Silver Wheaton has peaked, it is important to consider growth prospects, as well as the silver market as a whole. The company’s most recently announced deal with Hudbay Minerals demonstrates that growth is possible. While the company did have to outlay $500 million at closing to secure the deal, it is a very positive sign that the company is still able to add new streams to its portfolio.

The Trade

Overall, Silver Wheaton remains one of the best positioned companies in the precious metal space. Despite very positive performance over the past three months, the stock still has significant upside over the medium and longer-terms. While the most risk-averse investors may wish to wait for more aggressive entry points, the stock could pop and never look back. Having an allocation to Silver Wheaton should be a part of every well diversified portfolio.

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.

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