Silver Wheaton: Where Is The Bottom?

Dec.10.13 | About: Silver Wheaton (SLW)

I wrote about Silver Wheaton (NYSE:SLW) in April and May, and warned readers about short-term pressures the company was facing at the time. Silver Wheaton is still facing pressure, with Fed tapering coming closer, which might negatively impact gold (NYSEARCA:GLD) and silver (NYSEARCA:SLV) prices. However, when deflation fears abate and when inflation picks up, Silver Wheaton will benefit immensely and I see long-term gains for its shareholders, and the stock might bottom in the next 6 to 18 months, depending on the effects of Fed tapering on the economy and inflation.

Negative earnings cycle continues

Silver Wheaton remains in the fourth stage of the earnings maturation cycle. This stage is reflected by declining earnings and revenue, shrinking margins and negative revisions of analyst consensus estimates. The company is doing everything it can to boost its silver and gold streams, and production and sales of silver equivalent ounces increased in the last couple of quarters, partially offsetting declining spot prices. This was achieved by increased gold production, while silver production remained roughly the same since Q3 2012. Silver equivalent production increased at least 10% over the last 6 quarters, and at an average rate of 20.7% over the same time. This has kept revenue from falling significantly along with spot prices of silver and gold, but the increase in production will not be enough to stop a decline in revenue growth if the spot prices keep falling. TTM earnings per share declined over the last couple of quarters, and a further decline is expected, which is reflected in the falling analyst consensus estimates.

The company maintained its 2013 production goal of 33.5 million of silver equivalent ounces, while the 2017 production goal is now 42.5 million ounces from the previous goal of 49 million. This reduction in 2017 guidance is due to the delay at Pascua-Lama, although it was partially offset by the addition of the gold stream from Hudbay's Constancia project. This means that production will be 25% higher in 2017 than in 2013.

Weak inflation leads to low silver and gold prices

Gold and silver prices are largely dependent on the level of inflation. They perform well when inflation is high, and perform poorly in periods of low inflation and deflation. Gold and silver topped in 2011, coinciding with the top of the highest CPI levels since early 2008. Prior to the breakdown in gold and silver prices in the last two years, many believed that QE will prop up their prices, and this has not been true, because QE did not manage to move inflation higher since mid-2011. Gold and silver moved lower this year also after inflation kept falling, and on fears that the Fed will start tapering, which in turn might lead to even lower inflation or deflation.

This will pressure the price of gold and silver, and at the same time the price of Silver Wheaton, at least until inflation picks up, and when there is evidence that the tapering of QE will not lead to even lower inflation. I do not believe that a reduction of QE will lead to deflation, and the Fed stated that they will not reduce QE until the economy is on solid footing. And I also believe that the massive monetary stimulus all over the world will eventually result in rising inflation, and that is the time Silver Wheaton will benefit. But this is still not visible, and it might take a couple of years, when and if the world economy begins to recover significantly.

Click to enlarge

Source: October CPI report

Silver Wheaton to outperform once again when gold and silver prices rebound

Silver Wheaton has performed very well since the company was established in 2004. Early investors are still up close to 600%, while gold is up less than 200% over the same time. Silver Wheaton has also performed better than Global X Silver Miners ETF (NYSEARCA:SIL), Market Vectors Gold Miners (NYSEARCA:GDX) and spot silver since gold and silver prices peaked in 2011. Only gold performed better, which is to be expected, since gold is down 34% from its peak, while silver is down 60%. While there is a possibility of deflation in the future, the vast monetary expansion across the world is bound to produce inflation down the line, and I believe that Silver Wheaton is well positioned to benefit as gold and silver prices rebound after inflation picks up.

(click to enlarge)Click to enlarge

Silver Wheaton price performance versus GLD and SLV since 2004. Source: Yahoo! Finance

(click to enlarge)Click to enlarge

Silver Wheaton price performance from GLD peak in September 2011. Source: Yahoo! Finance

Conclusion

Although I believe that Silver Wheaton's price will be pressured in the next 6 to 18 months, as the Fed begins tapering, and as fears of deflation present themselves, I also believe that Silver Wheaton will provide an excellent buying opportunity for long-term investors in the mentioned period of 6 to 18 months. Silver Wheaton will probably find its bottom in that time-frame, if not sooner, depending on the outcome of Fed tapering and inflation expectations. When that happens, Silver Wheaton will once again outperform spot prices of gold and silver, as well as most of its peers. I remain on the sidelines until I see the consequences of Fed tapering, and the effects on the economy and inflation.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.