Did The Fed Cost Investors The Chance To Buy Silver Wheaton?

by Doug Ehrman

When our favorite character in the precious metal game, “Helicopter Ben” Bernanke took the podium on Friday, August 31st, he helped send precious metals and miners immediately higher. Not only did he indicate that the Fed is poised to initiate another round of quantitative easing, he also made it clear that as long as the unemployment rate stays steadily above 7%, quantitative easing will be a perpetual reality. The news had a positive impact on the price of Silver Wheaton (SLW), sending the stock 5.2% higher. While the company remains one of the best plays in precious metals, a prudent investor must ask if the spike means that he or she has missed the move and must wait for a better entry point. Ultimately, while it would be better to wait for a short-term dip in the stock, depending on one’s risk tolerance, entering the stock at current levels can be justified.

Silver Wheaton and Quantitative Easing

While past performance is never a guarantee of future results, there is merit to considering how Silver Wheaton performed during previous rounds of quantitative easing. During the first round, in the direct aftermath of the financial meltdown, the stock rocketed up 505%. To keep this in perspective, the stock had been badly punished during the meltdown, so a significant part of the huge move was a run back to normalcy. During the second round of quantitative easing, the stock was up 45%. To give these numbers an appropriate context, during the measurement periods, iShares Silver Trust (SLV) was up 68% and 81%, respectively. It is likely that the stock lagged the commodity during the second round as a result of its huge run during the first round. Clearly the stock has been helped by the Feds moves, much as one would expect. Silver has the ability to respond even more sharply than gold due to the fact the market is dramatically smaller.

Silver Wheaton’s Model

While it has been discussed in previous articles written on Silver Wheaton, the unique business model used by the company is worth covering for those who are unfamiliar with it. Silver Wheaton is not a mining company in the classic sense, but rather it is a silver streaming company. It does not operate any mines directly. Instead, the company contracts with other miners to pre-purchase the production of those miners at a predetermined price. In most cases, Silver Wheaton secures these contracts without the need to outlay any upfront capital. This means that the company bears very little operational risk.

With roughly eight hundred million ounces of silver reserves, the company controls more silver than any other single company. Based on the company’s most recent earnings release, with the acquisition of two new contracts, Silver Wheaton was able to lower its average cost on a per ounce basis to $4.04. In practical terms, this means that the company earns the spread between the market price of silver and its average cost. The value tied up in the company is significant.

The Impact of Bernanke’s Speech

The immediate reaction to the Fed Chair’s speech was to send the prices of both silver and gold higher. SLV finished the day 4.59% higher on Friday, August 31st, while  SPDR Gold Shares (GLD) ended the day 2.31% higher. The speech indicated that the Federal Open Market Committee (FOMC) was ready to act as soon as was deemed necessary, ushering in the third wave of quantitative easing. An additional position that seemed to come out of the speech is that the Fed will continue to act until the unemployment rate remains steadily below 7%. With the current rate of unemployment well above the targeted level, it seems clear that the Fed, and Ben in particular, plans to keep pushing until it is stopped by some outside force. This should be bullish for precious metals and those stocks, like Silver Wheaton, that are tied to the commodities.

The Peers

While Silver Wheaton is not the most aggressively priced of its peers on a valuation basis – the stock trades at a price-to-earnings ratio of 21.6, compared to 29.9 for Coeur d’Alene Mines (CDE) and 8.9 for Pan American Silver (PAAS). But it is the company’s operating margin that sets it apart. Silver Wheaton has an operating margin of 75% relative to 20% for Coeur d’Alene and 36% for Pan American Silver. This metric highlights the strength of the business model and why the company is a long-time favorite of investors.

The Trade

While it is not usually a good idea to buy a stock right after it has spiked by over 5%, this may be a unique case. The likelihood is that Tueday’s (9/4) trading session will reveal a lot about how the market is digesting this most recent bit of Fed news. If the stock continues sharply higher, which is unlikely, it may be necessary to wait until the price pulls back a bit to enter. If the stock retreats a bit, particularly near the open, it may represent a great buying opportunity. Another round of quantitative easing will almost certainly drive commodity prices higher, so Silver Wheaton is a great name to own. Finding a reasonable entry point can help an investor to maximize his or her returns.