Whenever I make a purchase, I like to share my buys to document my journey towards financial independence. This latest purchase diverges from the normal buys that I normally pursue, as I shared in this post – Multipronged Approach to Investing. So far, I have relied on companies with growing dividends, but the current market leaves me nervous wanting me to look elsewhere. I started to look at contrarian trades and looking for undervalued assets and decided to make my first move in this space.
One of the assets that have been depressed and currently hated in the investing world are precious metals. Metals such as gold and silver have seen immense downward pressure over the past few years. There are multiple reasons for this, some of which are listed below. Investing in precious metals can take many forms and I have discussed some methodologies here and here. To recount from those articles, investors may choose to invest using bullion (comes with ownership/storage costs), ETFs (paper contracts, loses the point of investing in precious metals) or mining companies (comes with risk, such as exploration risks, management issues, lack of understanding space etc). It is for this reason, I have decided to pursue the precious metals space using a different vehicle: streaming & royalty companies.
What is a streaming/royalty company? A quick note for those unaware of streaming companies. A streaming company is a company that provides upfront cash to mining companies. When mining companies want to fund projects, they go to streaming companies for funding and in return, the streaming company gets the right to buy the output from the mine at a fixed price (usually far below the market price of the metal in question).
I initiated a position in Silver Wheaton Corp (SLW.TO) with 50 shares @ C$25.24. The company yields 1.1% adding US$10 to my annual passive income. Nothing to write home about. But as I mentioned earlier, this investment is not focused on the dividend, but a contrarian move.
Company Overview
Silver Wheaton is the largest precious metal streaming company in the world. The company has entered into a number of agreements where, in exchange for an upfront payment, it has the right to purchase, at a low fixed cost, all or a portion of the silver and/or gold production from several high-quality mines located in politically stable regions around the globe. Silver Wheaton currently has streaming agreements for 22 operating mines and 7 development stage projects. The company’s growth profile is driven by a portfolio of world-class assets, including precious metal and gold streams on Hudbay’s Constancia project and Vale’s Salobo and Sudbury mines.
Recent Buy Decision
- First and foremost: the business model. Silver Wheaton may agree to buy silver at $5/oz (current spot price is ~$17/oz) and gold at $400/oz (current spot price is ~$1280/oz). Silver Wheaton will then sell at market price netting a profit on that massive spread. While each deal is different, for the most part, streaming companies usually own rights to the gold/silver for the full life of the mine.
- The materials/precious metals sector has been the most hated/underperforming sector over the past 3-4 years. This is a contrarian trade on my part starting to build a position in the sector.
(Image Source: Seeking Alpha)
- Some investors are already calling for taking profits and the rise in silver/gold is done for now. While the metals take a breather, a look at the long term charts shows that silver prices are still very depressed and present plenty of room to run.
- Exposure to precious metals. Looking at the macro economic view, the financial and monetary system faces a lot of challenges. It is not a question of ‘if’, but a question of ‘when’, the next recession or financial crisis will hit the markets. Once investors face challenges in the financial markets, everybody runs to safe havens such as gold and silver.
- Owning mining companies can be a risky endeavor for those who do not understand. I am not a geologist and find it hard to evaluate one mine’s asset vs. another. It is for this reason that I have chosen royalty/streaming company as my investment vehicle. Streaming and royalty companies like Silver Wheaton buy the rights to silver and gold from various mines across the world and at very attractive terms. The following chart shows the mining assets SLW owns rights for.
- Silver Wheaton provides exposure not only to silver, but also gold. Currently, silver makes 60% of SLW’s revenue and gold makes the remaining 40% of revenue.
- $8.3B company run by only 24 employees. With a current estimate revenue of $822M for 2016, that translates to a revenue per employee of $34M. Talk about efficiency!
- Silver is also an industrial metal used for various things. One aspect of silver that excites me is that it plays a crucial part in solar PV cells. With the renewable energy space gaining momentum, silver is a proxy (albeit a very small one) to invest in solar.
- The gold-to-silver ratio indicates that silver has more upside potential than gold.
Risks
- The continued strength in US$ means that precious metals can face continued pressure on the prices. This could be a damper on the stock price for Silver Wheaton.
- Silver Wheaton is currently facing an audit from CRA (Canada Revenue Agency) about taxes paid between 2005 and 2010. Silver Wheaton could possibly face a fine totaling C$353M (which SLW is confident will be resolved without a fine).
Summary
I have been eyeing precious metals investments for over a year now and have been thinking that the time was not right. The continued strength in US$ keeps the asset prices depressed and may continue to do so over the course of next couple of years. I wanted to see some movement before making my first move and we finally saw that with the US$ stumbling in the first quarter. I have now started making a move…and this is the first of many such purchases I will be making in hard assets such as gold and silver over the coming months. I still continue to hold one gold mining company – IAMGold (IMG.TO/IAG) in my portfolio, who’s stock price has doubled in the past couple of months (although its just back to my cost basis). Hard assets will provide safety when there are problems in the financial markets, and with the Fed hell-bent on destroying the dollar in order to achieve inflation, I want to accumulate hard assets much more than paper products.
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