Over the past three months, Silver Wheaton Corp. (SLW) has dramatically outperformed silver as a commodity. Using the iShares Silver Trust (SLV) as a proxy, the price of the stock is up nearly 30% during which time the price of SLV is up just shy of 10%. Given the company's business model, achieving amplified returns is to be expected, but with this level of divergence between the two, the savvy trader must consider if the stock has run too far to remain a good bet. Markets factors have set the stage for a significant move in precious metals prices, but this reality should not allow one to ignore the risks involved in any given trade.
Catalysts For The Move
Earlier this month, the company announced solid earnings results that have had a very positive impact on the stock's price. Against analyst estimates of $0.35 to $0.42 per share, the company turned in EPS of $0.40. Beyond the bottom and top line numbers, the company further announced important acquisitions, expanding its already market-leading silver reserves, as well as reporting a decline in the average cost the company pays for silver; the average cost per silver equivalent ounce fell to $4.04. This means that the company is now able to earn the spread between the market price of silver and a price just above $4 per ounce.
The decline in the company's average cost highlights a critical attribute that is often overlooked or simply misrepresented: Silver Wheaton is not a silver miner. Where companies like Great Panther Silver (GPL) or Pan American Silver (PAAS) face the risks of operating active mines, Silver Wheaton is a silver streaming company. One of the increasing risks faced by miners is the increased cost of mine clean up after a mine is closed. Intensifying environmental pressures are driving cleanup costs ever higher; Silver Wheaton has no exposure to this type of risk. Instead, as a silver streaming company, Silver Wheaton contracts with other miners to buy all or a portion of their production at an agreed upon price. In most cases, this agreement is reached with no capital outlay by the company, meaning that it carries very little risk. This is one of the reasons that the company is able to achieve an operating margin over 75%.
In addition to solid earnings results, falling average cost and positive acquisitions, the global macroeconomic stage has been set for an upward run in precious metals. With the slowing global economy and the European debt crisis as a backdrop, the announcement by the Federal Open Market Committee (FOMC) that further quantitative easing is nearly inevitable is extremely bullish for commodities, especial the metals. Gold and silver benefit not only from the general attractiveness of commodities during periods of concern over inflation, but from the flight to safety that generally weak conditions have created. Not only has the price of Silver Wheaton outperformed for the last quarter, as mentioned above, in the last month alone the price of the stock has climbed by 25% relative to a jump in SLV of just 11%.
The Way Forward
At this point, there are two distinct and divergent possibilities for Silver Wheaton moving forward. If the price of silver continues on a steady trajectory higher, it is likely that the price of the stock will follow suit. While the pace of the outperformance may slow, as long as silver prices are on the rise, it is unlikely that the stock price will get hit. Under this scenario, even those that have missed the significant price jump over the past several months may wish to enter the stock and participate.
The other possibility is that silver prices will face a correction in the near-term, and that this correction will be sufficient to significantly knock down the price of the stock. Under this set of circumstances, Silver Wheaton will not only dramatically underperform SLV, it may experience a significant fall in just a few days. Students of the silver market can attest to the fact that silver prices tend to march high slowly and collapse lower with ruthless speed. This is largely a function of the relatively small size of the silver market as compared to the gold market.
Given the fact that 2012 is an election year, the current administration in Washington will be under increased pressure to stabilize the economy in the coming month heading into Election Day. Signs of stabilization, however fleeting, may create the correction that brings silver prices tumbling lower. While the totality of circumstances is such that over the medium and long-term, it is probable that silver prices are heading much higher, investing in Silver Wheaton at these price levels carries this very real risk. Investors who are willing to be patient, possibly buying additional shares on corrections, should proceed with caution. Those who prefer to avoid volatility, or simply want a better price, should wait for a correction to buy this stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.