Silver Wheaton (NYSE:SLW) has seen its stock price plummet from around $35 at the beginning of the year to $18-19 currently, a precipitous decline of almost 50%. It’s not just Silver Wheaton that’s reeling – almost all companies operating in the precious metals space are sinking in the same boat, as gold and silver prices have been on a steep decline. The problems for Silver Wheaton are exacerbated by the fact that the company does not hedge itself against fluctuations in gold and silver prices. Its revenues and profit margins are a direct function of prevailing market prices because the cost of acquiring gold and silver from mining companies is fixed through long term contracts.
Silver Wheaton’s problems are being caused by macroeconomic factors as well as issues with Barrick Gold’s Pascua Lama project. The Federal Reserve Chairman Ben Bernanke has hinted at a possible withdrawal of the quantitative easing program later this year as long as the economy continues its recovery, and this is being held responsible for the plummeting gold and silver prices. Also, Barrick has been forced to delay the first production from its Pascua Lama mine in Chile and Argentina, from late 2014 to mid-2016.
- Why We’re Raising Our Price Estimate For Silver Wheaton To $20
- Gold Versus Silver: A Comparison Of The Demand Composition For The Two Metals
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- How Has Silver Wheaton’s Reporting Structure Changed?
- How Will Silver Wheaton’s Revenue Composition Change By 2020?
- Why We’re Revising Our Price Estimate For Silver Wheaton To $18
Plunging Silver Prices
The price of silver declined from nearly $31 per ounce at the beginning of the year to around $19 per ounce by the end of June. It touched a low of $18.60 per ounce towards the end of June before rebounding slightly to cross the $19 mark in the first few days of July. Ben Bernanke, the Chairman of the Federal Reserve Bank, has announced that if the U.S. economy and job market continue to improve, the quantitative easing program could be reduced or withdrawn later this year. Right now, the Federal Reserve is pumping nearly $85 billion into the economy every month. ((Silver Price Charts, Kitco))
The withdrawal of monetary injection could lead to higher interest rates and lower inflation expectations in the medium term. Silver is preferred as an investment because it is seen as a hedge against inflation and as an instrument that generates high returns in a low interest rate environment. If inflation is weak and interest rates rise, the attractiveness of silver as an investment option is lower. The U.S. economy also appears to be strengthening and money is flowing out of emerging markets back into the U.S. Within the U.S., money is flowing out of the relative safety of gold and silver into equities and other assets which is contributing to a stronger dollar, thus exerting downward pressure on gold and silver prices. However, the impact on prices of silver may be cushioned by the fact that it is also an industrial metal. If a modest amount of economic growth takes place, silver is likely to outperform gold. 
Gold and silver price movements tend to be positively correlated. A sell-off in gold due to panic among investors generally results in an adverse impact on silver as well. In the present scenario, we think that the recent fall in price of gold and silver has an element of panic to it and the sell-off in both is a bit overdone.
Impact Of The Delay At Pascua Lama
A few days back, Barrick announced an additional one and a half year delay before production can commence at Pascua Lama. This delay has resulted from a Chilean court order that bars Barrick from developing the project before it complies with regulatory demands. The company needs to carry out the construction of canals and drainage systems to divert run-off water away from the Pascua Lama mine. This is likely to take time and production is not expected to begin till the second half of 2016. ((Barrick Gold Delays Production at Pascua Lama Mine, Sets Big Charge, WSJ))
Silver Wheaton entered into a silver purchase agreement with Barrick in September 2009 to acquire 25% of the life-of-mine silver production from Pascua-Lama. Under the agreement, Barrick provided a completion guarantee that requireed it to complete work at Pascua-Lama to at least 75% of design capacity by December 31, 2015. The original agreement stated that in case of a production shortfall at Pascua Lama in 2014 and 2015, Silver Wheaton would be entitled to compensatory silver production from Barrick’s Lagunas Norte, Pierina and Veladero mines until Barrick satisfied the completion guarantee. If Barrick does not satisfy the guarantee, Silver Wheaton retained the option of terminating the agreement. Silver Wheaton has now extended the deadline by one year to December 31, 2016.
If this revised deadline is not met, Silver Wheaton will receive $625 million, the upfront cash consideration it has paid to Barrick. The amount payable to Silver Wheaton will be adjusted for silver delivered to it up to December 31, 2016. The compensatory silver streams, if any, from Lagunas Norte, Pierina and Veladero mines will still end on December 31, 2015. 
To reflect the delay at Pascua Lama, Silver Wheaton has revised its production forecast for 2017, from 53 million ounces to 49 million ounces. Pascua Lama is expected to produce an average of 35 million ounces annually in the first five years of operation and Silver Wheaton is entitled to 25% of production.
Based on a weak outlook for silver prices in foreseeable future and setbacks at the Pascua Lama project, we have revised our price estimate for Silver Wheaton to $20.Notes: