Following a sharp correction during the 2008-2009 crisis, prices of metals soared, hitting record or near-record highs in 2011. This was largely driven by Chinese demand, which began to fade late in 2011. Unstable recoveries in Europe and the United States also weighed on global demand. Global economic uncertainty, combined with the oversupply of many metals, led to a dramatic drop in commodity prices since 2011. The result has been devastating for the mining industry. There have been widespread cuts across the sector, from exploration and production to operating and capital expenses. Write-downs have been the norm for many miners in recent years, part of an industry-wide restructuring. This continued in 2014. Economic challenges, the strengthening U.S. economy and supply/demand imbalances have had a significant impact.
Silver, considered a hybrid metal for use as currency and in industrial applications, has been hit hardest, declining by 66% off the 2011 high to $16 per ounce. Silver is in a slump, but demand for the metal will continue given its versatility. It is used in many industries from electronics to automobiles. For those looking to pick a bottom on silver — now at a 10-year inflation adjusted low — my recommendation is to do it via Silver Wheaton (SLW).
Normally, if someone is bullish silver, or any commodity for that matter, they should go long that future or long an exchange-traded fund tied to its performance. However, SLW has a unique structure with paid-in-advance production that will allow it to profit exponentially if the price of silver spikes. SLW is a precious metals streaming company that engages in the exploration of silver and gold. The Vancouver-based company, founded by Peter Derek Barnes in 2004, has 20 long-term purchase agreements and one early deposit long-term purchase agreement associated with silver and/or gold related to 24 different mining assets. The company has silver and gold interests in a diversified group in mines around the globe.
Historically, mining companies have been limited to either borrowing or selling equity to raise the millions needed to build a new mine; something that has become increasingly difficult for many of the sector’s smaller players. But a third option developed in recent years is precious-metals streaming. It is an emerging method of mine financing. Streaming is a kind of arbitrage in which the company puts up large amounts of capital — up to $2 billion, in SLW’s case — for the right to buy a percentage of a mine’s future output.
SLW is the world’s largest precious metals streaming company and one of the largest producers of silver, despite not owning a single mine. Streaming allows SLW to purchase the by-product — silver or gold production — of a mine that it does not own or operate. The operating costs that SLW pays for future production are pre-determined in the agreements, typically at about $4 to $6 per ounce for silver and $400 per ounce for gold, with a small inflationary adjustment in most contracts. SLW’s streaming assets are 80% silver and 20% gold. The model greatly lowers business risk, compared with companies directly involved in mining.
SLW has a number agreements in place where in exchange for an upfront payment, it has the right to purchase at a low fixed cost all or a portion of the silver and/or gold production from 18 high-quality mines and five development stage projects around the globe.
Based on SLW’s current agreements, its attributable production for 2014 was 36 million silver equivalent ounces, including 155,000 ounces of gold. By 2018, the annual attributable production is anticipated to increase to 48 million, including 250,000 ounces of gold. Growth from 2015 to 2018 will be driven by the company’s portfolio of low-cost and long-life assets, including gold streams on the Vale Salobo and Sudbury mines, along with the silver and gold stream from the Hudbay’s Constancia project. SLW, valued at $19.86 on May 7, is a buy up to $22 and should bounce to the high $20s or low $30s range.
Note: This column is an excerpt from a 37-page report written by the author on SLW, NEM and FCX.