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November 13, 2008

Silver Wheaton

With things feeling rather grim this early afternoon, I decided to put on my contrarian hat and find something to dabble in on the long side. For some time, I have had my left eye on the chart of Silver Wheaton. I like the way this company has structured their business as basically a middleman for silver production. Silver Wheaton enters long-term contracts with individual mines to purchase silver production at a fixed cost, under $4 per ounce. They acquire such a favorable price by providing an up-front payment which the contracting mining company can use for capital equipment or other purposes.

This arrangement makes SLW a leveraged bet on silver, and therefore effectively makes SLW shares a silver option without an expiration date... assuming the company itself doesn't expire. It seems unlikely that a company purchasing silver under $4/oz would run into trouble, especially since their contracts state they get to buy the metal at the lesser of $3.90 and the market price. A little due diligence reveals a solid balance sheet with net assets of $3.57/sh (I picked up SLW at $2.71 today), positive cash flow, and a trailing PE of 6.6. One minor concern is that Goldcorp, which owned 48% of SLW, sold the entire stake in a February offering. I'd like to know why. Anyway, concern over this sale is mitigated by the fact that SLW shares were 400% higher at the time of sale.

The primary crticism of this trade would be a matter of patience. Why buy now instead of waiting for the commodity market to bottom out to get the wind at my back? First, I believe commodity-related issues will be relatively strong if we see our mid-term rally finally materialize, and as I stated above, I was simply looking for something to buy in what seemed like a panic situation. Second, miners are terribly undervalued relative to the metals. Although SLW is not a miner, it moves in a correlated manner. Finally, I dabbled small today. This is a position I intend to build... or perhaps axe... depending on circumstances.


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