SLW: Is Selling the Poor Man’s Gold Paying Off?

Some things just don’t change. This timeless saying buttresses the fact that no matter how we try to dress something up to appear more attractive it will likely be short-term and superficial. This applies to the fortunes of silver which, for some time late last year and early 2012, was rising and tracking gold as a rising safe-haven investment. However, the performance of silver over the past six months has seen the metal fall from its recent highs in a continuation of its downward trend. Gold, on the other hand, has maintained a much steadier value, given its reputation as a safe-haven metal during a particularly potent financial crisis. Whilst silver has always been considered as a lower-demand and less valued metal, it has far more utility than gold which is acquired rather than utilized. The value of gold, however, is held in the desire of investors to store its protective intrinsic value in times of economic hardship rather than have any particular use for it. This is where gold and silver are very different. Silver is a precious metal with a number of uses and functions; both its wide pharmaceutical and industrial uses have made it a valuable spot metal to trade. Despite this, as a safe-haven instrument, silver is pretty much worthless in the eyes of the investing public.

The Silver Wheaton Corporation (NYSE: SLW) is one company that is going to have to work extra hard to prevent a detrimental effect on its stock price as a result of the recent pullback in the prices of its sole product. It will have to increase the volume of silver it mines and sells, as opposed to trying to benefit from an increase in the value of silver.

When a company’s product is one where is [intlink id=”16″ type=”category”]stock prices[/intlink] are effectively tied to a commodity and are subjected to market bias as a measure of supply and demand, it can be very tricky business indeed. Silver is traded actively on the markets, and it is subject to a market bias which can drive its price up or down. Putting this in to context, a product like an iPhone is not traded on the financial markets and is not subject to such daily variations in prices as we see in spot metals. This means that for an iPhone, prices will tend to be more stable and will be a subject of demand and supply in real-time situations; it also means for Apple that they can focus in output rather than wildly fluctuating handset prices. This is not the case for Silver Wheaton Corporation, which is subject to the daily price swings of silver in order to determine its fortunes. On two occasions in late 2011, the price of silver dipped by 35% in a matter of days. What does this sort of volatility mean for a company whose flagship product is silver?

What it means is that the company itself and its investors are standing on thin ice virtually all the time. In a hypothetical situation, a company that makes $10million from selling 500,000 ounces of silver to a phone maker or a pharmaceutical company that makes silver nitrate at $20 an ounce, will only make $8million if it sells 800,000 ounces of silver at $10 an ounce. The silver company is still selling, has not seen a cutback in orders, and indeed has even seen an increase in its orders, but is still making less money. What happens to this company’s[intlink id=”13″ type=”category”]stock[/intlink]? It will lose value as investors will offload it to seek more profitable ventures.

This is the unfortunate situation that Silver Wheaton has found itself in today. Despite a modest first-quarter recovery in silver prices, this trend is not likely to be sustained as fundamentals based on demand for the metal, along with an improving global economic outlook are pointing to a renewed round of falling prices. Some of the heavy silver buyers in China and other parts of Asia have scaled back on their orders. Liquidity is low, and there is a lot of silver supply without a matching demand to sustain rising prices. Moreover, silver’s newly forged identity as a safe-haven asset when it rode on the back of rapidly rising gold prices appears to have petered off.

The outlook for Silver Wheaton is currently negative, and it will not be a surprise to see further declines from present prices which are hovering around $30 a share to a share price below its current 52-week low. Something positively extraordinary has to happen to silver prices in order for us to see a short term recovery in the share price of Silver Wheaton. Although it is not impossible that a rally may attempt to break the back of the current downtrend, it would take either some beneficial product diversification, or a substantial increase in either output or the commodity price in order for Silver Wheaton to begin to appear as a positive buy.