Silver Wheaton (NYSE:SLW) has seen an impressive run up in price over the last few months thanks to a strong rally in precious metals. There are several factors in SLW's macro environment that make the equity a favorable investment; however, there are risks in the rising U.S. dollar and a potential rate hike from the Federal Reserve, as well as the looming CRA audit. I'm cautiously bullish on the environment for precious metals, but will not buy in to SLW because of the CRA headwind. I prefer to allocate capital elsewhere.
As I've detailed before, the primary risk for shareholders in SLW, in my opinion, is the Canadian Revenue Agency's ongoing audit of previous tax years. In the May update to shareholders, Silver Wheaton gave a brief update that the "pleadings" are closed, meaning that the CRA will be giving a decision on the company's previous tax years within the next few months. The exact timeline to a decision, however, is unclear. Again, it's not that SLW can't pay these fines, it's that, if imposed in full, would be a significant blow to liquidity and would hamper key growth projects, like Rosemont in Arizona. Additionally, if these fines are imposed in full, investors will need to be realistic in that this company will not nearly be the capable buyer it was last year when it purchased Antimina from Glencore (OTCPK:GLCNF, OTCPK:GLNCY). This potential hit to growth is another reason to avoid SLW.
Click to enlargeSource: Investor Relations.
The reality is that if this CRA headwind was not present, the company would present itself as a high-streaming, quality precious metals company with significant growth prospects for the long-term. That would be an ideal situation, but because this headwind is in place, investors should look elsewhere in the equity market to allocate capital, despite the macro environment being decently favorable.
A Favorable Macro Environment?
Investors need to be concerned with four core macro factors as trading heads into the summer. First, the potential rate hike from the Federal Reserve, which could come as soon as next month. Second, the Brexit vote in late June and its implications. Third, the potential renewal of the Greek debt crisis, and finally, the strength of the U.S. dollar, especially following the FOMC meeting next month. This will be critical in examining the potential long-term impact on precious metals and precious metals driven equities.
The Federal Reserve's Intentions
This is the central focus of gold and silver traders alike at the present moment and is promised to move the needle on both precious metals. The markets are now pricing in at least one hike this year on the back of cautious optimism from Chairwoman Janet Yellen. Precious metals have been retreating as of late based upon recent words from Yellen and the rest of the Fed, indicating that a hike may send gold much lower, likely below the $1,200 support level. Additionally, it may send silver well past the $15.50 level,
All investors learned from Yellen's Harvard speech today was that she wants to see the economy "behave" itself before the Fed raises rates in an attempt to hit the 2% inflation target. I think this reduces the pressure to raise rates next month, but a summer rate hike is not out of the question.
Yet, unsupportive economics tell a different story. Particularly, I've been focusing in on declining corporate earnings, now for the third straight quarter. This is the worst corporate performance since the financial crisis and while much of it has to do with the energy sector's downturn, the broader market isn't fairing so well. This isn't exactly bullish fuel for the Fed's potential rate hike next month.
Source: The Wall Street Journal.
Precious metals may also be experiencing push and pull from politics as Election Day draws nearer and nearer. If the Fed fake hikes in June and states that they want to delay it until after the Presidential election in November, then gold and silver longs will see the most profit.
The economics at home are not only unsupportive of a rate hike, but also the economics abroad paint a less than desirable picture for future corporate earnings. Major players in the global market like Japan and the ECB are saturated with negative interest rate policies, which, while aimed at spurring growth, are seeing nothing but disappointing figures. This is excellent fodder for new long positions in gold and silver, especially over the long-term given the lack of quick changes to these policies.
Particularly, investors should keep a careful eye on Greece if targeting an entry into precious metal driven equities like SLW. While Greece is being propped up by funds from the IMF over the next several months, the reality is that this places the European Union in a marginally weaker liquidity situation than before. A lot of uncertainty revolves around this country and given that the creditors are calling for strict changes within the government, gold and silver stand to be beneficiaries of this country's medium-term increased volatility.
Based on the polls coming in, it looks as though there's a strong chance that a Brexit will not occur. Especially in light of a report from the U.K. Treasury that dropped this morning saying that citizens who place a portion of their savings into pensions would be negatively impacted in terms of the value of their fund. This has created negative sentiment prior to the June 23 meeting, which should be taken down as a landmark day for the European markets.
Thus, for those watching precious metals movements, it's critical that the GBP/USD pair be examined in order to consistently factor this wildcard play into investment decisions. The U.S. dollar will assuredly look a lot more favorable against the GBP if the country decides to exit the European Union. This is negative for gold, considering it's a rise in the U.S. dollar, but at the same time, the uncertainty revolving around Brexit fears is bullish.
The importance of the dollar as it relates to SLW cannot be undermined. After declining significantly over the past few months and spurring a rally in SLW, it has bounced back for the previous three weeks with all the optimism surrounding a June rate hike. If the dollar continues its May trend, the shorts of SLW are in favor, but if the Fed becomes bearish or more cautious on the economy's near-term condition, the dollar will retreat and SLW will benefit. Thus, the FOMC meeting next month garners a significant amount of importance.
Can precious metals go lower? That's the question Silver Wheaton longs need to ask themselves. The best part is that markets are currently uncertain, especially with the indexes rallying back towards their all-time highs over the past few months. That bodes well for precious metals. As for the fundamental data, investors are getting a mixed bag in that the potential rate hike and a rising U.S. dollar are bearish, yet fears over the broader equity market, a potential Brexit, and Greece's instability create a bullish sentiment.
Disclosure: I/we 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.