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How to Buy Silver for Just $4 an Ounce

Precious metals investors may not be too keen on silver after the last year or so. It’s currently in the high $20s, down from a peak of $45 or so in 2011, giving it a nearly 50% decline in under a year.

But what if you could buy silver for just $4 an ounce?

That’s what Silver Wheaton (NYSE:SLW) does. This Canada-based metals company is not a miner but a “streaming” company. In layman’s terms, it fronts mines a bit of money to fund production — and in return, owns a “stream” of silver that comes from production.

Or in the words of Silver Wheaton CEO , SLW offers “the mining reward without the mining risk.”

Silver Wheaton was a pioneer of the streaming model and has now grown to a market size of almost $10 billion — quite impressive for a silver firm that doesn’t itself own or operate a single mine.

I recently had an opportunity to talk with the CEO Randy Smallwood about his company’s unique model, what investors should know about its operations and where he thinks silver prices will go from here. Here are the highlights of our conversation:

Q: Some investors may mistakenly think you’re a mining company, but Silver Wheaton is the world’s largest silver streaming company. Can you explain the difference?
We started this company back in 2004 on the streaming model — we were the first company that came up with streaming… what we do is buy the rights to a certain percentage of silver production. When we buy that, we make an upfront payment and then commit to a fixed delivery cost when our silver is delivered to us.

And so we have a fixed operating cost, and our capital cost is the actual purchase price upfront. So, we don’t have any cost surprises, which is a really big difference from some of the traditional mining investments where capital costs and operating costs are subject to different pressures. Our costs are fixed, so it becomes a very, very pure exposure to the actual metal itself…. I like to say we deliver the mining reward without the mining risk.

Q: So for a practical example: In the first quarter, it looks like your average per-ounce price for silver was about $4. Has that changed at all in recent months?
A: No the costs are fixed, and so I can tell you exactly what our costs will be next quarter and the quarter after that — right in around that $4 range. Each one of our contracts has a schedule on it in terms of what we pay on a yearly basis per ounce of silver delivered to us.

Q: Since you’re not actually pulling the metal out of the ground, what are some of the mining companies you partner with that investors may recognize?
Our two flagships right now are Barrick Gold (NYSE:ABX) and its Pascua-Lama project in South America. It’s under construction right now but expected to be delivering silver to us in the middle of 2013. In full production for the first five years it will deliver 25% of its silver to Silver Wheaton. That will be about 9 million ounces per year to our credit.

The second company is GoldCorp (NYSE:GG) with its Penasquito mine in Mexico, which they have just started and just recently reached full commissioning. We get 25% of whatever silver that mine produces for the life of the mine, which should average around 7 million ounces per year.

We also have contracts with Glencore at the Yauliyacu mine in Peru, Glencore being one of the largest mining corporations in the world, and Lundin Mining (PINK:LUNMF), another decent-size mining company and Nyrstar, a decent-size mining and smelting company.

Q: Silver is a precious metal, but there are some practical uses beyond coins and luxury goods. Generally speaking, do you think this helps the long-term demand and add stability to pricing?
Definitely. Especially as we get more and more demanding about electronics. As the world goes more digital, we get more and more demanding about our efficiencies in terms of how fast and how powerful our phones are or how good our solar panels are. Every year when we go to a higher efficiency for electronics in terms of actually moving electricity, silver usually plays a role.

Silver is the best conductor out there in terms of its weight in regards to the amount of electricity it moves through. It’s big in mobile electronics, and in fact, one of the biggest consumption areas is solar panels as we look for higher energy conversion rates.

There are also antibacterial qualities to silver getting to be more and more understood, where you mix a little bit of silver with your medical instruments or Band-Aids, and it really greatly reduces the chance of bacterial infections. We’re really beginning to understand why Egyptians drank their water out of silver chalices — or at least the wealthy Egyptians — was because of the antibacterial qualities that helped purify it.

It’s also worth noting that in these uses, silver is actually consumed. So, its very tough to recover the silver through recycling and put it back into use, which drives the demand side, too.

Q: I won’t ask you to give a price target, but broadly and directionally where do you see silver going from here? Do you think we’re around a floor in silver prices after their flop from 2011 highs?
I see a strong market for silver. One of the key things, silver has always been known as the poor man’s gold or the affordable precious metal. And what we see is a very large middle class developing and continuing to grow in both China and India, and a very strong relationship with silver in both those cultures as a store of value. And as that middle class grows, they’re going to want to have stores of value, and silver is a very affordable approach to precious metals.

We continue to see strong investor demands out of those markets and strong demands in the U.S. with respect to investment.

And there’s also not a lot of growth on the supply side. One of the advantages to silver and what makes it unique is that only 30% of silver comes from silver mines. 60% actually comes from base metal mines, from copper mines and lead-zinc mines. The supply side has this natural restriction because copper mines don’t change their production when silver prices go up. They’re driven by copper prices. The lead-zinc mines don’t change their production plans or rates because of silver prices. Again, they are driven by lead prices or zinc prices.

So, if you see a bit of a slowdown in terms of the economy and industrial activity, it usually has the biggest impact on base metal supply — but indirectly, it impacts silver supply because base metal mines aren’t producing as much, and it restricts the supply of silver. It’s a very unique metal in the fact that so much of it is produced as a byproduct.

Q: Silver Wheaton initiated its first dividend in 2011, and then quickly tripled that dividend last December. Not to put you on the spot, but are there any plans for another dividend increase this year?
Dividend growth is important for us, but right now we see so many opportunities to continue growing the company that our focus is to put as much cash flow as we can back into ounces in the ground.

The number of opportunities we see in the market right now are very attractive. With the current credit and equity markets right now there are lots of opportunities for us to supply financing for mining companies to build there projects. So, our focus is to put as much cash into the ground we can and convert that into ounces.

But as our company matures, we will turn into more of a dividend machine. We have plenty of capacity with our fixed-cost structure and a very unique dividend policy where it’s a percentage — 20% of our operating cash flow is fed back to shareholders, and that means they get a direct connection to silver prices via the dividend. And as our company matures, that 20% level will climb. But right now we’re striving to put as much into the ground as we can.

Q: Any final thoughts that we haven’t covered you’d like to share with people?
Just that our company is stronger than it’s ever been, and we’re very well cashed up when there are plenty of opportunities out there for investment. We are very optimistic about the rest of 2012 in terms of continuing to grow, with well over a billion dollars in capacity in terms of making investments, and the market is very receptive to that.

Lots of companies out there are very desperate for capital to help grow themselves, and we’re going to be selective, but we are excited for the opportunities.

Jeff Reeves is the editor of and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace??.com or follow him on Twitter via @JeffReevesIP. As of this writing, Jeff Reeves did not own a position in any of the stocks named here.

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