“Why ‘Canadian Silver’ Could Pay 100% MORE than Ordinary Silver Over the Next Few Years…” (PS, there’s “Canadian Gold”, too)

by Travis Johnson, Stock Gumshoe | September 24, 2012 2:09 pm

Sniffing out the "Canadian Silver Program" details from Matt Badiali's S&A Resource Report

Huh? Are the Canadian Maple Leaf silver[1] coins[2] going to suddenly become twice as valuable as the American Eagle silver coins[3]? No, don’t worry, it’s not that simple and silver is still fungible, an ounce is an ounce is an ounce (well, a troy ounce, anyway).

So what’s the idea of “Canadian silver” being somehow better than “ordinary silver?” Well, it’s a teaser pitch from Matt Badiali[4] for his S&A Resource Report newsletter, and he tells us that this kind of silver has been dramatically more profitable than the types of silver investment you might be more familiar with, like silver miners or silver coins … let’s sample a bit of the ad to give you an idea what he’s talking about:

“Why ‘Canadian Silver’ Could Pay 100% MORE than Ordinary Silver Over the Next Few Years…

“…Even if the Price of Silver Doesn’t Go Up a Single Cent

“Some of the Best Money Managers in the World – including several Billionaire Hedge Fund Managers – have already Invested Millions in this Lucrative Silver Opportunity….

“…this opportunity is something you can participate in via the stock market.

“And the people behind it have agreements in place that allow them to acquire silver at the ridiculously low price of just $4 per ounce on average… which they can then resell at the current, much higher rates (an ounce of silver currently costs more than $30)!”

Ah, OK — so there are a bunch of savvy Gumshoe readers who figured this one out based on that last paragraph … but not everyone is steeped in silver stocks, so don’t spoil it for the rest of the group, we need to check the rest of the clues first!

OK, fine, we’ll give you a hint — rhymes with “Buster Keaton.”

More clues from Matt Badiali?

“Since 2005, an investment in the thriving “Canadian Silver Program” has soared 1,008%, while the price of silver bullion has lagged far behind increasing by only 375%.

“And it gets even better, because unlike any other silver investment I’m aware of, this “Canadian Silver Program” generates consistent income. As an equity shareholder, you’ll receive frequent payouts based on the price of silver and other factors….”

Lovely — income is always good.

And then we get the spiel about all the rich, smart people who already own buckets of this stock (OK, fine, yes — I gave it away early, it’s a stock, not a secret kind of silver):

“… some of the richest investors in the world are getting in on this opportunity early….

“Billionaire precious metals investor Eric Sprott, also known as ‘the Warren Buffet of Canada[5],’ calls silver the investment of this decade. And he has invested millions of dollars in this unique ‘Canadian Silver Program.’

“John Van Eck has also caught on to the incredible bargain and explosive upside this money-making silver opportunity offers. Van Eck is the founder of Van Eck Global with $35 billion under management and currently holds over half a billion dollars of ‘Canadian Silver Program’ stock.

“Other large investors include the Oppenheimer Funds, JP Morgan, Vanguard and Fidelity[6]. Each has invested $15 million or more in this lucrative ‘Canadian Silver Program.’

“And the ‘Canadian Silver Program’ is one of Presidential candidate and Congressman Ron Paul’s top holdings and best performing investments with a reported return of as much as 1,135% over the past 10 years.”

Leaving aside for a moment that Eric Sprott is so close to being the polar opposite of Warren Buffett[7] when it comes to investing style (so much so that Sprott has called out Buffett, as if for a cage match fight, several times … pretty much whenever Buffett says anything bad about gold[8] or silver), he is certainly an asset manager whose moves make people notice, and he has been very vocal over the past year or two about his expectations that silver will be where the huge money is made in the next big run. And no, most people don’t call him the “Warren Buffett of Canada” — that term has been bandied about regarding Eric Sprott a few times, sure, but Bruce Flatt at Brookfield and Prem Watsa[9] at Fairfax Financial are much more often (and more reasonably, I’d argue) blessed with the “Buffett of the North” sobriquet. I dream of someday being called the “Warren Buffett of the I-91 Corridor of West Central Massachusetts Between Springfield and Greenfield,” but I’m afraid that even if I narrow down the geographic range further I’m unlikely to be so blessed.

We had a point though, didn’t we? Ah, yes — the “Canadian Silver Program” … perhaps another scoop of clues will slow my blather:

“The ‘Canadian Silver Program’ has an unusual origin.

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“It was actually started by a 25-year mining industry executive who stumbled upon a financing secret in the oil and gas business, and figured out a way to apply the same strategy in the silver sector.

“In short, this fellow found a safe and lucrative way to get paid lots of money in these industries… WITHOUT having to do any drilling, mining or production.

“He started the ‘Canadian Silver Program’ in 2004 while he was working at GoldCorp – one of the largest gold mining[10] companies in the world. When this unusual business was part of GoldCorp, it was a side-project. There were no dedicated employees… it was simply administered by this gentleman and a few other guys who ran the gold mining divisions.

“But the idea took off almost instantly and within a few years, the ‘Canadian Silver Program’ was a booming billion dollar enterprise. A full-time executive team was put in place and the company was spun off into its own thriving business.

“In short, what these guys figured out how to do is use their capital and expertise to get an early stake in some of the best silver mines – including 3 of the top 4 silver deposits in the world.

“And because they get in so early, they are able to lock in EXTREMELY low price guarantees for silver that comes out of the ground… without having to do any of the actual work!

“Today, these guys not only have a stake in 3 of the top 4 silver mines in the world, but also 9 of the top 40 silver mines in the world.

“And as a result, they are getting paid massive amounts of silver production profits, without doing any of the hard work and without all the risks and costs of a full-scale mining operation…..

“the company behind the ‘Canadian Silver Program’ paid just $4.09 per ounce for the 24.6 million ounces of silver they received in 2011.

“Obviously, with silver selling at around $30/oz. for much of last year, they made a heck of a lot of money.

“You can get in on the “Canadian Silver Program” on the New York Stock Exchange (NYSE). That’s because the ‘Canadian Silver Program’ is not actually a ‘program.’ It’s a publicly traded company that gives everyday investors an incredible opportunity to participate in the profits to be made by buying silver at just $4 per ounce and selling it at the market price – currently over $30 per ounce and rising.”

OK, fine — yes, it’s Silver Wheaton (SLW), the silver “streaming” company that has been freakishly successful thanks both to the brilliance of their model and the success of the mines they helped to finance when silver was in the dumps.

And the teaser describes the basic operations of the company pretty well — silver is almost always produced as a byproduct of other mines (there are precious few major primary silver mines in the world, mines who are mostly trying to produce silver), and miners hate that they always have to sell equity to finance their mines just at the point before they think their price will go up.

So the solution? Sell off some of that valuable by-product before you even start mining, and use those funds to develop the mine. If you’re really after copper[11] or gold or zinc[12], selling off the few thousand ounces of silver that you’ll probably produce as you hunt for those minerals is a decent compromise, even if silver prices are weak when you sell them. So Silver Wheaton went around and offered not only to buy access to these streams of silver up front, but also to pay for each ounce when it’s produced (so it’s not a royalty — they don’t just sit around and collect their share, they actually buy each ounce — which means it also costs less than buying a royalty).

The big gains from these kinds of companies come in three ways:

• First, successful mines often (usually, even) grow far beyond the “reserves” that they have when they are first built, since there’s no need to spend money to drill and identify new reserves if you already have eight years of mining mapped out … so that means the mine produces for longer and produces much more over time than was figured in numbers they used to value and pay for the initial streaming plan.
• Second, the commodity price rises, giving extra leverage[13] and increasing margins dramatically. This obviously doesn’t always happen, since prices can go down even if they haven’t done so much lately, but Silver Wheaton struck deals for buying silver at $4-5 an ounce when silver was in the low teens, a reasonable discount that has become a gargantuan bargain now that silver prices are around $30.
• And third, these companies compound earnings and naturally grow margins like nobody’s business (even if commodity prices don’t really rise). They have extremely high profit margins that rise as they grow (their real cost after the initial capital investment, once you net out the contractual per-ounce price of silver, is just people and expertise — if you have a dozen experts to analyze and shepherd each streaming deal, they can do the same with more or larger deals … increasing the size of the cells in your spreadsheet doesn’t cost anything, and an accountant can process a million dollars almost as easily as a thousand). So as cash flow streams in from these deals, they can use much of that cash to make new deals on mines that will begin operating in a few years, keeping the pipeline of future cash growing.

I don’t own any silver miners right now, but just as I’ve said several times in regards to gold I love the streaming and royalty companies — diversified to reduce risk from any one mine, detached from the cost overruns and permitting and strikes and high energy costs that beset pretty much every miner at some point, and usually run lean and clean.

Silver Wheaton is not as cheap as it was a year or two ago — so you’d pay a forward PE of about 18 to get in now. But they are still growing quickly, and benefitting from some spectacular, young mines that will be producing for (probably) decades, like Penasquito and Pascua Lama. Surprisingly enough for such a huge company, they have fewer than 20 operating mines right now that are producing silver for them, which speaks to the huge size of several of these mines — Royal Gold (RGLD)[14], by comparison, which does royalties largely on gold mines, has 39 active producers in its portfolio and more than 100 developmental and exploration projects, and Royal Gold is less than half the size of Silver Wheaton. SLW is diversified to some extent, but they have some giant hits in their portfolio that have really boosted returns. You can see their portfolio here if you’re interested[15] — unlike with royalty firms, who sometimes invest very early in exploration to get that royalty (albeit with smaller investments sometimes), streaming firms like Silver Wheaton often put their money in substantially later in the process, when there’s a pretty clear timeline to production or when the mine has already been producing and just wants to invest in expansion or “monetize” a future metals stream.

Analysts are expecting Silver Wheaton to keep growing earnings by more than 20% a year for several years into the future, but that’s obviously very dependent on silver prices — if prices fall, their profits fall, even if there aren’t many people who believe that silver will fall back below $5 in the foreseeable future and make their streams completely unprofitable. It’s worth noting that it’s not just silver, too — Silver Wheaton is passive, they have no control over the mines from which they receive silver, so if those mines stop operating or cut production SLW often has little or no recourse. So if the 777 zinc/copper mine run by Hudbay shuts down (that’s SLW’s newest acquisition, and a big one) because zinc prices crater, then Silver Wheaton is out of luck on that particular silver stream from the 777 mine even if silver prices happen to be doing fine. Mines are not operated and managed to maximize the production of secondary metals, and most of Silver Wheaton’s mines produce silver as a secondary or tertiary “by product” metal. So that’s a risk if the balance between silver and the primary metals changes, even if silver pricing stays solid or rises — they need zinc, gold, copper, etc. to do reasonably well, too. And, of course, it will help if none of their mines has other major problems — but the beauty is, if it’s just regular problems like having to pay the miners more, or spending more to explore than they expected, or buying new equipment, Silver Wheaton gets to be passive on that, too — they don’t have to pay anything more than the per-ounce price that they agreed to up front.

So yes, if I were going to invest in a silver stock for the long haul it would probably be Silver Wheaton. I do not currently own any silver-focused stocks, though I do hold some physical silver and I generally do expect silver to do well — it hasn’t recently been “tested” as a financial asset the way gold has, and it still has pretty heavy industrial uses and a low per-ounce price that makes it more accessible to individual hoarders, but I don’t have a particular crystal ball that tells me whether silver or gold will do better at maintaining buying power over the next decade, so I own a bit of both. Silver has undeniably been far more volatile than gold, and Silver Wheaton as a somewhat leveraged play on the metal is more volatile than the Silver price … which is probably part of the reason why Silver Wheaton has generally been cheaper than Royal Gold.

And yes, Silver Wheaton is also an income producer — they have a policy to pay out 20% of operating income as dividends[16], which puts them on track for about a 1% yield going forward — though with production expected to grow by more than 50% over the next three or four years, I’m sure that dividend can grow nicely as long as silver prices don’t drop sharply.

It’s also worth warning you that there is a lot of chatter about Silver Wheaton’s tax status — they are currently being audited by the Canadian tax authorities, and there are plenty of folks who think this is a death knell. Given what I’ve heard from the company I have no particular reason to be concerned — Silver Wheaton operates through tax haven countries to generate most of their income, and they think that their non-Canadian income is not taxable and seem confident that their structure will stand up to scrutiny and won’t result in them owing more taxes on the 2005-2010 years — but I don’t own the stock, and I don’t know what the result of the audit will be. That seems to be the largest overhang on the stock, and the biggest potential negative, but the company has consistently said it is routine and they expect to be audited frequently going forward because of their large size — so you can make your own call on that. It seems likely that unless Penasquito, 777, San Dimas or Pascua Lama shuts down unexpectedly, or the silver price falls markedly, that the tax issue being fretted about by investors is probably the largest potential near-term risk. It wouldn’t stop me from buying the stock right now, though, as I said, I don’t own it personally.

And a bonus? Yes, we hear later in the ad that there’s also apparently a “Canadian Gold” program:

“The ‘Canadian Gold Program’

“Remember the ‘Canadian Silver Program’ I was telling you about at the beginning of this presentation?

“Well there’s actually a new business that’s starting to do the same thing in the gold industry.

“It follows the same highly-lucrative and proven business model of providing capital to promising gold mining projects in exchange for a percentage of the gold production over the life of the mine.

“The striking similarity is no surprise considering one of the executives behind the cash-gushing ‘Canadian Silver Program’ was hired to build the company we call the ‘Canadian Gold Program.’

“And his experience is paying off. He’s quickly creating another highly profitable venture. In less than 4 years, he has built a $600 million business – and it’s growing fast.

“To date, the ‘Canadian Gold Program’ has interests in 9 gold mining operations – all of them in politically stable regions of North and South America. Investing in stable locations is a primary focus because it reduces risk and creates more predictable and stable revenue streams.

“The strategy is producing impressive results. In 2011, the ‘Canadian Gold Program’ generated $30 Million in revenue (an 852% increase over 2010) on production of 18,500 ounces of gold (a 697% increase over 2010).

“And these figures are set to explode over the next several years as gold production ramps up. Projections for 2012 are 25,000 to 35,000 ounces of gold increasing to 50,000 ounces by 2015 – nearly tripling production over the next three years. ”

And that one, dear friends, is Sandstorm Gold (SAND in NY, SSL in Canada) — which is your friendly neighborhood Gumshoe’s largest holding and which I write about ad nauseum[17], including in the latest Friday File[18] for the Irregulars. Yes, they’re a streaming company focused on streams and royalties from gold (and also now platinum[19]) miners. Unlike Silver Wheaton, which has bought “byproduct silver” for the most part, Sandstorm Gold has been buying gold mostly from primary gold mines — but, at least in the beginning, buying into smaller or harder to analyze mines who may have more trouble accessing friendly financing. Their latest deal does actually incorporate the byproduct idea, buying a big chunk of the platinum from a developing gold mine (and some gold, too), but most of their gold streams come from gold-focused miners.

Sandstorm is approaching a $1 billion market cap so they’re no longer teensy, but they are much smaller than Silver Wheaton (SLW), which itself is by far the largest of the streaming/royalty companies, much larger than the other major gold-focused firms Franco-Nevada (FNV, market cap $8 billion) and Royal Gold (RGLD, market cap $6 million). Silver Wheaton is also by a most measures the least expensive large royalty company, and pretty much always has been (though it has closed the gap some this year with a nice run), but by my reckoning Sandstorm is the least expensive of the gold-focused companies.

And yes, Nolan Watson[20], the CEO of Sandstorm Gold, cut his teeth as an incredibly young CFO for Silver Wheaton before he left to start his own firm. And if you’re worried about the Cayman Islands subsidiary that owns many of Silver Wheaton’s streaming assets, well, you’ll probably worry about Sandstorm, too — Sandstorm also uses an offshore tax haven, in their case Barbados, to own their streaming assets and relieve some Canadian tax liability. So if Silver Wheaton gets slapped, Sandstorm will also feel it.

If you’re thrilled by the hunt for exciting little emerging mining stocks, by all means, go hunting. But if you want some of the upside from discoveries and expanding mines and rising commodities prices without worrying as much about the challenging business of actually getting the stuff out of the ground, check out the royalty and streaming companies — Sandstorm Gold has been the best of the four I mentioned (SAND, RGLD, SLW, FNV) over the last two years and I happen to think that will remain the case going forward, given its small size and the easier path to growth from that smaller base, but it’s also riskier because of the smaller size and, unlike the others, does not pay even a paltry dividend. And really, all four have done very well and, given good gold and silver prices, will most likely keep doing very well.

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