Will Silver Wheaton Continue To Outperform Silver?

| About: Wheaton Precious (WPM)
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Following the positive results of Silver Wheaton Corp. (SLW) for the second quarter of 2012, the company's stock sharply rose in recent weeks; in August, it rose by 21.3%. During 2012 the stock increased by 9.8%. By way of comparison, during the month, the price of silver rose by only 5.7%. iShares Silver Trust (NYSEARCA:SLV) also increased by only 4.6%. Will Silver Wheaton continue to outperform the price of silver?

It's not trivial for Silver Wheaton to outperform silver. After all, the company's stock outperformed silver only in recent weeks. Furthermore, during 2011 Silver Wheaton's stock declined by 24.5% while silver price fell by only 10.3%.

In the chart below are the normalized prices of Silver Wheaton's stock, silver, and the S&P 500 (prices are normalized to Jan. 3, 2012). As you can see, Silver Wheaton's stock rose in recent weeks, and due to this rally the stock nearly matched the growth of the S&P 500 during the year. The decline of silver contributed to the low growth of Silver Wheaton's stock during most of the year. Furthermore, the linear correlation between silver and Silver Wheaton reached 0.65 during 2012. This means, under certain assumptions, nearly 37% of the stock's volatility could be explained by movement of silver prices.

Click to enlarge image.

When comparing Silver Wheaton and the price of silver, you should consider that the company is offering a divided of $0.36 per share. That is nearly a yearly yield of 1.2%, while just holding silver offers none.

The price of silver didn't perform well during the year. But there are some events that could help rally silver. If the ECB starts its bond purchasing program to help the EU countries in raising debt, this could rally the euro, which tends to be positively correlated with silver. During 2012, the linear correlation between silver and euro/USD is 0.477, which is a mid-strong and positive relation. Today's publication of the minutes of the FOMC, and the next FOMC meeting to be held on Sept. 13, might affect silver. If the FOMC introduces another stimulus plan and if the strong and positive relation between precious metal prices and the expansion of the U.S. money base remains strong, this news could rally silver.

The company's recent rise was most likely prompted by the good performance of the company during the second quarter: The sales of the company reached $201.4 million compared to $194.7 million during Q2 2011 -- an increase of 3.4%. This rise was despite the decline in silver price that adversely affected net earnings, which fell by 4.5% from $148 million in Q2 2011 to $141 million in Q2 2012. The price of silver declined (from Q2 2011 to Q2 2012) by 24.2%, while the sales of silver (in ounces) rose by 36.4% during said time.

On the other hand, the company produced less silver in the second quarter of 2012 than in the first -- the company produced 6,501 thousand of ounces in Q2 2012 and 6,609 thousand of ounces in Q1 2012. And yet the company sold much more silver during Q2 2012 than in Q1 2012; the company sold 6,789 thousand of ounces in Q2 2012 and 5,928 thousand of ounces in Q1 2012.

Besides the positive financial reports of the company, the recent acquisitions and business developments of the company with other bullion companies may have also contributed to the rally of the stock price. If the company continues to expand its operations and mining, it could keep the stock's upward trend intact.

But if the price of silver continues to dwindle, this will further lower the company's profit margins and lower the risk (in regard to acquiring new mines and companies) the company's management will be willing to take. During the second quarter the net profitability reached 70%, compared to 73.6% profitability during Q1 2012 and 76% profitability during Q2 2011.

Therefore, if the company continues to expand its operations and acquire more mines, it could raise the company's production, which will result in higher sales. But if the price of silver doesn't rise, it could curb the company's recovery and lower Silver Wheaton's earnings growth.

For further reading, see "Gold And Silver Outlook For Aug. 20-24."

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.