The silver market hasn't performed well during the year (so far). Furthermore, other silver related companies such as Silver Wheaton Corp. (SLW) also haven't done well. Will the price of silver and shares of Silver Wheaton keep falling? Let's examine what might revive the silver market in the coming weeks. Let's also analyze the latest developments of Silver Wheaton including its newest acquisition.
During 2013 (up to date), shares of Silver Wheaton fell by 4%. In comparison, the price of silver decreased by 2.5%. iShares Silver Trust (SLV) declined by 3.1%. The chart below shows the developments of Silver Wheaton, silver and S&P500 index (normalized prices to the end of December, 2012). As seen, both silver and Silver Wheaton have under-performed the S&P500.
So what is next for silver and Silver Wheaton?
Silver Wheaton's recent Purchase and Financial Reports
Silver Wheaton will publish its fourth quarter financial report on March 21st. Until then, let's take a close look at the company's latest acquisition. The company recently acquired from Vale S.A (VALE) 25% of the life mine of the Salobo Mine (gold production) and 70% of Sudbury Mines (gold production). This agreement will augment Silver Wheaton's exposure to gold from 12% to nearly 25% by 2018. Was this deal a good one for the Silver Wheaton? The answer depends on the assumptions. Based on the agreement's parameters (including price of acquisition ($1.9 billion), estimated production (110k ounces of gold) and lifetime of mines (20 years)), this deal has a positive NPV under a 0% discount rate. If the discount rate is 5% or 10%, the NPV of this agreement is mostly negative.
The table below presents the summary of the NPV calculations for this project.
Additional Parameters: The base case considers the price of gold to reach $1600 per t. ounce starting 2014. The cost of production is $400 per ounce that rises by 1% annually. The company will pay for this deal $1.9 billion. It will also give a warrant for 10 million common shares of Silver Wheaton within the next 10 years for a strike price of $65. I didn't add the warrant to the pricing of this agreement. On the other hand, I didn't add the expected growth in the Salobo mine from 12 million tonnes per annum to 24 million tonnes per annum by 2016. This is another upside that could make this deal much more profitable for Silver Wheaton. So this deal is profitable only under the 0% discount rate. Otherwise, this deal is profitable only if the price of gold will spike well over $1800.
Let's turn to the silver market. If silver doesn't rally in the months to come, the profitability and revenues of Silver Wheaton will be adversely affected by it. So will silver change course and rise anytime soon?
Silver Price Doesn't Rise
The price of silver hasn't performed well in 2013 (up to date) as it has declined by nearly 2.5% (year-to-date). Does this mean silver will keep falling or start to rally anytime soon?
One factor that might contribute to the recovery of the price of silver is the growth in the U.S money base. The launch of the Fed's long term asset purchase program from back in December is starting to show in the augmentation of the U.S money base. This move might raise the concern of investors against the potential devaluation of the USD. In such a case, this could increase the demand for safe haven investments such as silver.
The chart below shows the developments of the monthly price of silver and the U.S money base between 2011 and 2013. As seen, the price of silver spiked in 2011 alongside the sharp growth in the U.S money base that grew (most likely) on account of the Fed's QE2 program. The U.S money base is picking up again as the QE3 program is currently running. Moreover, the linear correlation between the two data sets is 0.37, which is a mid-strong relation. This means, assuming all things are equal, if the U.S money base will keep rising, it could pressure up the price of silver.
Despite the relation between the U.S money base and silver, the effect of the rise in the money base might have a diminishing return on the silver market so that even if the money base will rise, the price of silver will partly be affected by it at best. In the coming weeks it will become clearer if this relation still holds.
My guess is that unless the upcoming fourth quarter financial reports of Silver Wheaton will surprise with a sharp rise in revenues on account of an increase in production, shares of the company will continue to dwindle. Moreover, the recent acquisition of the company raises its exposure to gold, which, much like silver hasn't performed well in recent months. Unless the price of gold will spike above $1800, this acquisition might not prove to be profitable. Finally, if the price of silver will keep falling, this could also pressure down the value of Silver Wheaton.
For further reading see" Will The Gold Market Continue to Cool Down?"