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Silver Wheaton Corp. (NYSE:SLW) has increased its gold production in recent months. Moreover, the company's gold production is expected to triple in 2013. Is this the right move for this company? What is next for the gold and silver markets?

Silver Wheaton's recent decision to purchase Sudbury and Salobo led to a spike in the company's gold production in the first quarter of 2013: Gold production sharply rose from 2,088 ounces in the first quarter of 2012 to 32,227 ounces in the first quarter of 2013. Furthermore, gold sales generated 13.5% of the total revenue in the first quarter of 2013 compared with 3.2% in the first quarter of 2012.

According to the company's outlook for 2013, Silver Wheaton's gold production will reach 145 thousand ounces, nearly three times the amount of gold produced in 2012. Conversely, the company's silver production will fall by 4.1% in 2013 (year-over-year). Therefore, gold sales will generate 24% of the total revenue in 2013 compared with only 9% in 2012. Is this the right move for this company?

Is gold better than silver?

A quick examination reveals the profit margin on gold is lower than on silver. Based on the company's financial reports, the profit margin on silver reached 86.3% in the first quarter of 2013; the profit margin on gold was only 78%.

The table below shows the profit margins on silver and gold in the past several years (the 2013 average cash cost of silver and gold were estimated based on the same growth rate in costs they had in 2012).

(click to enlarge)

This means gold is less profitable than silver. Perhaps gold will diversify the company's revenues?

Diversifying with gold

Diversification isn't a bad idea for a company where 90% of its revenues come from silver. But since the price of silver and gold are strongly correlated, augmenting the company's gold operations won't diversify its revenues. The chart below shows the strong linear correlation between gold and silver during 2013.

(click to enlarge)

Will gold recover?

Based on the Gold Council's recent quarterly report the demand for gold fell during the first quarter by more than 13% (year-over-year). Most of the drop in demand for gold was due to the outflow in ETFs that reached 177 tons in the first quarter of 2013. Conversely, the demand for gold in China and India rose during the quarter by 20% and 27%, respectively. The demand for gold coins, bars and jewelry also increased during the quarter. But the main issue remains the demand for gold as an investment. Will the demand for gold in this sector continue to dwindle? One factor that may affect the price of gold is the future plan of the FOMC. In the latest FOMC meeting, the Fed left its policy unchanged. Following Bernanke's testimony in Congress regarding the Fed's economic outlook, the speculations about the Fed tapering its current asset purchase program may have contributed to the fall of gold prices during the week. If the Fed will start to cut down QE3, this could reduce the demand for gold as an investment against the potential devaluation of the USD. The next FOMC meeting to be held on June 18-19 might shed some light on the Fed's next move.

In the meantime, the SPDR Gold Trust (NYSEARCA:GLD), the leading gold ETF, continues to experience a large outflow: its gold holdings fell by nearly 25% during the year (up to date). iShares Silver Trust (NYSEARCA:SLV) also hasn't done well in the past several months as the its price fell by 26.4%. Moreover, if the prices of gold and silver continue to decline, they may pull down precious metals stocks such as Silver Wheaton and Royal Gold (NASDAQ:RGLD).

Takeaway

I still think Silver Wheaton is a very interesting investment for those who wish the expose their portfolio to silver. But I also think the company's recent decision to invest in gold mines may prove to be costly and won't pull up the company's stock in the near future.

Source: Is Silver Wheaton Moving In The Right Direction?