This might seem counterintuitive, but if you're a long term silver bullion bull like me, but are worried about the seemingly relentless selloff that is currently plaguing the commodities markets, it might make sense to buy a silver streaming company Silver Wheaton (NYSE:SLW) instead of silver bullion or its proxy (NYSEARCA:SLV). Most investors incorrectly believe that Silver Wheaton is highly leveraged to the price of silver, but fail to recognize that its long term contracts to purchase silver at much lower prices actually acts as a sort of hedge against declining silver prices.
If you buy an ounce of silver and the price declines, you have no chance of making money unless you're a silversmith or alchemist. However, Silver Wheaton can still remain profitable even as the price of silver drops. Of course, they won't earn as much profit on each ounce sold, and the price of the stock will fall accordingly, but I don't believe Silver Wheaton should ever trade for less than the spot price of silver.
The reason for this stems from the value of its long term contracts, where it provides an upfront payment to miners (mostly gold) for the right to buy their silver byproduct. Miners are willing to accept terms very favorable to Silver Wheaton, because of the high (and rising) cost to bring a mine online. Once the mine begins producing, Silver Wheaton enjoys collecting the silver stream for years to come, often for the entire life of the mine, with only the nominal additional cost of actually buying the silver for very low prices, usually around $4 an ounce.
This of course can be extremely lucrative in times of rising silver prices, as evidenced by SLW's 775% return since silver bottomed at the end of 2008, versus a return now under 150% for the SLV index. I believe SLW is once again poised to drastically outperform the price of silver, due to its unique structure that obviously benefits from increasing silver prices, but it can also generate gains from increasing production.
The latest decline in the price of gold and silver could actually be a boon to Silver Wheaton, as its up front financing becomes more important than ever to miners that are now struggling as operating costs have outpaced the price of their products. Silver Wheaton now has additional bargaining power in negotiating long term deals that should prove beneficial to shareholders. Given Silver Wheaton's track record in growing production over the last several years, shareholders can expect production to continue growing during good times, and perhaps even more in seemingly bad environments like right now.
If you think of each share as entitling you to a certain amount of Silver Wheaton's production, you can begin to see the benefit of owning SLW over SLV. In 2013, Silver Wheaton expects attributable production of approximately 33.5 million silver equivalent ounces, rising to approximately 53 million silver equivalent ounces by 2017. Since there are about 355 million shares of SLW outstanding, you can think of each share as having the right to buy and sell 0.09 ounces of silver this year and 0.15 ounces in 2017. Assuming a steady rise in production, you might expect to collect over half an ounce of silver by 2017, which may not sound like much, but when the company is buying it for $4 and selling it on your behalf at spot prices, it certainly seems preferable to having to pay market prices yourself.
If the price of silver goes nowhere over the next 5 years, you will not make anything by buying bullion and it will not have generated any earnings. However, if you own SLW, it will have bought and sold a growing amount of silver for you, and you would have claim over a rising amount of earnings, not to mention a 2% dividend that automatically grows along with their cash flow.
I will continue to hang on to my Silver Wheaton and perhaps even buy more as the price of silver declines, knowing it will probably generate about an ounce and a half of silver for me over the next 10 years, which it will buy for under $5 and sell for much more. This certainly seems preferable to spending the same twenty bucks and change for the ounce of silver that SLV represents, since it pays no dividend, has no growth, and you have to actually sell it to realize a profit.
I prefer to have SLW buy and sell my silver for me, which they will continue to do as long as I hold my shares. Who says you can't have your cake and eat it too? And when flour goes on sale, it might be a good time to invest in a baker like Silver Wheaton that will continue to cook up profits for years to come.