Silver Wheaton (NYSE:SLW) is a precious metals streaming company which signs long term purchase agreements with mining companies producing silver or gold as a by-product. It provides funds for capital expenditure upfront when a project is being developed and obtains the right to buy precious metals produced at low, fixed prices. The silver or gold obtained at a fixed price is sold at market rates. The company does not pay for any ongoing capital or exploration costs at the mines. Such a business model greatly lowers its business risk, as compared to other companies that are directly involved in mining.
In this article, we focus specifically on the company’s precious metal streaming agreement for Hudbay Minerals’ Constancia mine. We will incorporate various dimensions of the streaming agreement such as the reserve base at the mine, expected output, upfront payments made by Silver Wheaton, and the per ounce cash cost paid.
The Constancia Mine and Streaming Agreement
The Constancia copper project is located in the Chamaca and Livitaca districts in the province of Chumbivilcas in Southern Peru. Constancia will be an open pit mine, producing molybdenum in addition to copper, along with silver and gold by products. The project is expected to begin commercial production in 2015. 
On August 8, 2012, Silver Wheaton entered into an agreement with Hudbay to acquire 100% of the life of mine silver production from the Constancia project. On November 4, 2013, the company amended the agreement to include the acquisition of 50% of the life of mine gold production from Constancia. Under the amended agreement, Silver Wheaton will pay Hudbay a total cash consideration of $429.9 million, of which $294.9 million has been paid as at June 30, 2014, with an additional payment of $135 million to be made once capital expenditures of $1.35 billion have been incurred at Constancia.  In addition, Silver Wheaton will make ongoing payments of the lesser of $5.90 per ounce of silver and $400 per ounce of gold, both subject to an inflationary adjustment of 1% beginning in the fourth year, or the prevailing market price per ounce of silver and gold delivered. 
The Constancia mine will average 2.4 million ounces of silver and 35,000 ounces of gold production attributable to Silver Wheaton between 2015 and 2019. Gold production will average 18,000 ounces of gold over the rest of the mine’s life, which is expected to be 16 years. ((Silver Wheaton’s September 2014 Corporate Presentation, Silver Wheaton Website)) As on December 31, 2013, the Constancia mine’s proven and probable reserves stood at 61.1 million ounces of silver and 0.56 million ounces of gold. ((Silver Wheaton’s 2013 40-F, SEC)) This is sufficient to support the envisaged rates of extraction over a 16-year period.
Benefits to Silver Wheaton
As per the information available on the company website, we will assume a 16-year life for the Constancia mine.  The $429.9 million upfront payment for the streaming agreement translates into an average cost of roughly $26.87 million (~429.9/16) per year. As per the terms of the streaming agreement, the mine is expected to average 2.4 million ounces of silver and 35,000 ounces of gold over the first 5 years. The mine is expected to average 18,000 ounces of gold for the next 11 years. We will assume that that just like the expected gold production, silver production will drop to around half of initial production as well, that is 1.2 million ounces, for the remaining 11 years of the mine life. Over the life of the mine of 16 years, the average annual acquisition cost of precious metals under the agreement will be $18.62 million. Adding the average upfront cost, the total annual cost adds up to $45.49 million. Taking current market prices of gold and silver of roughly $1,220 per ounce of gold and $18 per ounce of silver, the average market value of precious metals purchased per year under the agreement is $56.79 million. Thus, Silver Wheaton would make a profit of around $11.20 million per year on average, or around 25% of the average annual cost, on its streaming agreement for the Constancia mine.
Even if we consider an inflationary adjustment of 1% on the purchase price under the deal, there is still scope for a profit. Taking into account an inflationary adjustment of 1% on the purchase prices under the deal, the purchase prices in the final year (year 16 in our estimate) would be roughly $455 per ounce of gold and $6.71 per ounce of silver. The company would still make a profit of around $0.43 million in the final year of production, including the average annual upfront cost, considering today’s market prices of silver and gold. Thus, Silver Wheaton’s streaming agreement for the Constancia mine looks like a good deal.
Demand for gold and silver over the term of the agreement will mainly be driven by major emerging economies such as China and India. With robust economic growth, rising middle class populations with growing disposable incomes, these countries will drive the jewellery, investment and industrial demand for gold and silver. In 2013, China accounted for 26% of the global private sector demand for gold.  Chinese private sector demand for gold is expected to grow from 1,132 tons per year in 2013 to 1,350 tons per year in 2017. ((China’s Gold Market: Progress and Prospects, World Gold Council)) Between 2009 and 2020, the global middle class will grow from 1.8 billion to 3.2 billion, with Asia’s middle classes tripling to 1.7 billion by 2020.  These trends will provide support to gold and silver prices and ensure the success of Silver Wheaton’s streaming agreement for the Constancia mine.Notes:
- Constancia Mine, Silver Wheaton Website [↩]
- Silver Wheaton’s Q2 2014 Earnings Report, SEC [↩] [↩]
- Silver Wheaton Acquires Life of Mine Precious Metals Streams From Hudbay’s 777 Mine and Constancia Project, Silver Wheaton News Release [↩]
- China’s Gold Market: Progress and Prospects, World Gold Council [↩]
- The Rise of The Global Middle Class, BBC [↩]