Precious metals have been crushed since reaching highs in October 2012. The most popular precious metals ETFs, such as the SPDR Gold Trust (GLD) and the iShares Silver Trust (SLV), are still down 2% and 3% in the last three months, respectively. The ETFs that track many of the companies that mine and sell these metals are down much further. The Market Vectors Gold Miners ETF (GDX), the Market Vectors Junior Gold Miners ETF (GDXJ) and the Global X Silver Miners (SIL) are down even further in the last three months compared with the metals they produce, losing 16.6%, 21.1% and 15.1%, respectively. Given recent sell-offs and the long term-tailwinds that gold and silver prices have due to central bank stimulus, I am reiterating right here that the gold and silver ETFs mentioned above are now strong buys after their massive sell-offs.
The Business of Streaming
While conducting thorough research for numerous prior articles on precious metal companies (which I am reiterating as solid long-term buys given the recent sell-off), I became familiar with a unique and solvent business model in the gold and silver space known as "streaming." I encourage investors in traditional precious metal mining stocks to consider streaming companies as an alternative, as I believe the approach these companies take offer a stronger opportunity for revenue growth with lower long-term overhead and will perform well in 2013. 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 believe will outperform the gold and silver metals and mining sector in 2013. These companies are Silver Wheaton (SLW) and Sandstorm Gold (SAND).
Silver Wheaton; A Premier Silver Company
Silver in physical form, as well as one of the ETFs that track silver prices and silver company stocks are investments that I have recommended for some time now. 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 18 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.
How SLW Operates
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 company most recently added a gold stream. SLW on 2/4/13 announced that it has entered into an agreement with a subsidiary of Brazilian mining company Vale (VALE) to purchase one quarter (exactly 25%) of the entire lifetime gold production from Vale's Salobo Mine in Brazil. In addition, SLW will also have the rights to 70% of the gold production from Vale's Sudbury Mines in Canada over the next 20-year term.
As part of the agreement, SLW will pay Vale just under $1.9 billion in cash as well as give Vale 10 million warrants to the company for a term of 10 years, at a premium price of $65 each. SLW will also pay ongoing allotments of $400 or the market price, whichever is cheaper, for each ounce of gold delivered. The beauty, is that SLW can than turn around and sell that gold and market and pocket the difference. SLW expects the deal to add 110,000 ounces of gold a year over the next 20 years (equating to 2.2 million ounces) and believes both of Vale's mine locations offer incredible expansion possibilities, further increasing the value of SLW's upfront investment. In the press release, SLW stated that the agreement will boost company revenue derived from gold from a previous average of around 12% to a peak of around 25% for the next five years.
Thus, the higher the price of silver and gold goes, the better the top and bottom lines will be. This efficient business model creates long-term shareholder value.
SLW Most Recent Quarterly Report
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 holds its value or the more likely case, appreciates over time, the stock should perform well.
SLW currently trades at $37.11 and has a 52-week trading range of $22.94 to $41.30. On average, about 3.8 million shares exchange hands daily. The company trades at a 22 P/E multiple but only a 0.65 PEG ratio and currently yields 0.75%. 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.
Whereas SLW is the world's largest silver streaming company, one of the premier gold streaming companies 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.
How SAND Operates
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 Recent Quarterly Performance; Record Revenue Was Achieved
SAND's second quarter was strong as it reported record sales and revenue. 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 revenue 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.
SAND Stock Fundamentals
Shares of SAND currently trade at $12.42. This is up significantly from when I first highlighted the company. The stock has pulled back over 15% from the highs of 2012 and I think it is a good entry point for the long-term investor. On average, approximately 650,000 shares exchange hands daily. The stock has ranged from $5.85 to $15.43 (this takes into account when it was listed in the OTC markets).