Silver Wheaton Corp. (TSX:SLW)(NYSE:SLW) is starting to move higher after the big pullback, and investors are wondering if a new rally is about to begin.
Let’s take a look at the current situation to see if this stock deserves to be in your portfolio.
Silver Wheaton’s business model
Silver Wheaton doesn’t actually own any mines; it simply provides upfront cash to the mining companies to help them move their projects from the development stage to production.
In return for the funding, Silver Wheaton is given the right to purchases gold or silver produced at the mine for very attractive prices.
The company reported Q2 2016 average cash costs of US$4.46 per ounce of silver sold and US$401 per ounce of gold sold. This resulted in cash operating margins of US$12.72 per ounce of silver and US$866 per ounce of gold. That’s not too shabby!
Gold is becoming a larger part of Silver Wheaton’s streaming mix, hitting a record production level of 130,000 ounces in the first half of 2016. That’s almost double the output from just two years ago.
Why would miners do these deals?
Most of the contracts are negotiated on mines set up to produce base metals, such as copper and zinc. The gold and silver that are produced are considered by-products.
Commodity prices have been in a downtrend for most of the past five years, making it difficult for miners to raise funds. Many companies have balance sheets that are loaded with debt and stock prices that have fallen so much that issuing new shares to raise capital would be too dilutive.
As a result, Silver Wheaton and the other streaming companies offer an attractive source of alternative funding.
Gold and silver outlook
The gold market enjoyed a nice rally in the first half of 2016 as investors realized the U.S. Federal Reserve wasn’t going to raise interest rates as quickly as expected.
Why is this important?
Higher rates increase the opportunity cost of holding non-yielding gold and tend to boost the value of the U.S. dollar, in which gold is priced. As such, rising rates tend to be negative for gold prices.
The rally ran out of steam shortly after the Brexit vote, and precious metals have been on the slide for most of the past three months.
The Fed is now expected to raise rates once before the end of the year, and analysts are looking for signs to suggest how many moves could be on the way in 2017.
At this point, the market could go either way in the near term.
If the Fed gets aggressive next year, gold will likely fall. If weak data and instability in global markets keep the Fed on hold, the gold rally could accelerate.
Silver tends to follow gold’s moves, but industrial demand also plays a factor. The global market currently has ample supply, but rising demand from the solar industry could tip the silver balance in the coming years, especially if new base metal mines don’t come online fast enough. Roughly 70% of primary silver output comes from mines set up to produce other products.
Should you buy today?
If you are a gold and silver bull, Silver Wheaton is a great way to play the recovery.
The stock is still up 90% on the year, so there is definitely a risk of another leg to the downside. As a result, I would keep new positions small and look for further weakness to add more shares.