Precious metals have posted solid gains in the last six months following global central bank actions to stimulate economies worldwide. The SPDR Gold Trust ETF (GLD) is up 10.7% in the last six month. I have suggested that both platinum and silver could outperform gold in the coming months. Over the last six, the ETFS Physical Platinum Shares (PPLT) and the iShares Silver Trust (SLV) are up 12.5% and 22.3% respectively. While money was made in the metals and mining stocks in that time, I believe there are still profits to be made in the gold, silver and platinum companies near-term, and without question in the long-term.
In the summer prior to the major run in precious metal stocks, I pounded the table on the gold miners and the silver miners as I repeatedly encouraged investments in the Market Vectors Gold Miners ETF (GDX), the Market Vectors Junior Gold Miners ETF (GDXJ) and the Global X Silver Miners ETF (SIL). I further highlighted some of the major individual mining companies such as Barrick Gold (ABX), Goldcorp (GG), Silvercorp Metals (SVM) and Pan American Silver (PAAS), which I hypothesized would outperform the broader market if central bank stimulus was conducted. All of these equities are up significantly since that time and all remain great buys long-term on any weakness.
The business model of streaming companies
While conducting thorough research for these prior recommendations (which I am reiterating as solid long-term buys), I became familiar with a unique business model in the gold and silver space known as "streaming" and would encourage investors in traditional precious metal mining stocks to consider streaming companies as an alternative. A streaming company generates its profits by providing up front financing for mining companies looking to expand and drill for precious metals. In exchange for the up-front financing of these companies, the streaming company acquires the right to purchase a portion of production generated from the mines at a fixed cost. I would like to highlight two companies involved in silver and gold streaming (there are more in the space) that I am closely watching over the next 12 months that I believe could outperform traditional miners. These companies are Silver Wheaton (SLW) and Sandstorm Gold (SAND).
Silver and silver company stocks have been ones that I have recommended for some time now and although there are many strong silver companies, SLW is by far my favorite silver stock. I believe it could not only outperform silver in the next year, but also the bulk of other silver companies. SLW is a worldwide silver streaming company, and is one of the most efficiently run companies in the mining and metals sector. SLW has contracts with companies around the world to purchase silver production in bulk at prices well below market value. Once SLW acquires the silver at the predetermined upfront investment cost, it then proceeds to sell the silver at higher prices. The company currently has 14 long-term silver purchase agreements and two long-term precious metal purchase agreements whereby it acquires silver and gold production from companies located in Mexico, the United States, Greece, Sweden, Peru, Chile, Argentina, and Portugal.
According to the company, "the predetermined price that SLW pays for future silver production is approximately $4.00 per ounce, with a small inflationary adjustment, ensuring that costs are fixed." SLW represents an excellent investment to gain exposure to silver as SLW offers significant leverage to the price of silver with minimal downside risks. No additional capital expenditures or exploration costs are required by SLW besides the initial payments the company makes to silver miners to secure the rights to purchase low cost silver. Further, SLW benefits from the production and exploration growth of its operating partners. It does not face the rising labor cost issues that actual miners face. So long as the mines are producing, SLW will have a consistent stream of silver and in turn a stream of revenue. The higher the price of silver goes, the better the top and bottom lines will be. This efficient business model creates long-term shareholder value.
The recently reported third quarter earnings were below analysts' estimates, primarily due to irregularities between ounces sold and timing of shipments. However, management stated that cash flow and dividends both will increase through the last three months of this year as sales begin to catch up with production. Production was up in the third quarter, rising to 7.69 million ounces of silver, however sales rose less than 1% to just 5.14 million ounces. Sales dropped by 13% to $161.3 million. Net income dropped by 11% from last year's $135 million to $119.7 million.
Although the quarter was weaker than expected the company looks strong going forward and is leveraged to silver prices. So long as silver hold its value or the more likely case, appreciates over time, than the stock should perform well. SLW currently trades at $37.06 and has a 52-week trading range of $22.94 to $41.30. On average, about 4.4 million shares exchange hands daily. The company trades at a 24 P/E multiple but only a 0.99 PEG ratio and currently yields 0.77% (the company reduced its quarterly dividend to 7 cents temporarily). Earnings per share are estimated to grow at a rate of 37% in the next five years. The company also has a great balance sheet with a debt to equity ratio that is minimal at 0.7.
While SLW is a bellwether in the silver streaming space, an up and coming streaming gold company is SAND. Interestingly SAND is headed up by CEO Nolan Watson. Nolan Watson served as the former CFO of SLW and thus he is familiar with the business model of streaming. Mr. Watson has demonstrated success. During his time with SLW, the stock moved from about $8 a share to over $20. I think he will deliver for shareholders of SAND as well. As with SLW and silver miners, SAND provides upfront financing for gold mining companies that are looking for capital for exploration and development. In return for upfront financing, SAND receives a gold streaming agreement giving SAND the right to purchase a percentage of the gold produced by the company. More specifically, SAND has the right to a percentage of a mine's gold production for the life of the mine. SAND currently has a portfolio of seven gold streams, five of which are now producing gold and two royalties. SAND plans to grow and diversify its low-cost production profile through the acquisition of additional gold streams. SAND is a growth-focused company that is seeking to acquire more of these gold streams from companies that have advanced stage development projects or operating mines.
SAND's second quarter was strong as it reported record sales and revenues. In its Q2, SAND sold 9,259 ounces of gold and had cash flow of over $11.3 million. The standout statistic of the quarter in my opinion was that SAND paid an average of $298 per ounce of gold, leading to cash operating margins of $1317 an ounce. SAND also just reported third quarter earnings. In Q3, SAND had record revenues of $15.1 million on gold sales of 9,066 ounces. Cash flow was still strong at $10.6 million. Margins decreased slightly on gold sales as the cost per ounce was $408, resulting in cash operating margins of $1258 per ounce. Margins were still very strong in my estimation. Finally, based on existing gold stream agreements, the forecast for attributable production in 2012 is 31,000 to 34,000 ounces of gold, increasing to over 60,000 ounces of gold equivalent per annum by 2015.
The current share price is $12.35. This is up significantly from when I first highlighted the company, but I still think it is a good entry point for the long-term investor. On average, approximately 690,000 shares exchange hands daily. The stock has ranged from $5.45 to $15.43 (this takes into account when it was listed in the OTC markets).
Due to central bank stimulus that will undoubtedly debase currencies worldwide, I believe precious metals are in a long-term bull market. We have had a slight pullback from the recent highs following central bank action, thus presenting an entry point opportunity for the long-term investor. Streaming is becoming one of my favorite business models in the entire precious metals space as the risk is much lower compared to traditional miners. Therefore, I will be closely watching both SLW and SAND in the next 12 months and think it is likely the stocks could outperform those of the traditional mining companies. Further, I believe both of these streaming companies are strong buys after their recent pullbacks and may outperform their peers that engage in traditional mining activities.
Additional disclosure: I have orders placed to initiate a position in SLW at $35.25 and SAND at $11.20