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How to Buy Gold for $400 an Ounce and Silver for $4.40

Mining is not an easy business. There are geological and engineering challenges — not to mention the capital expense — involved with extracting precious metals from the earth. There’s geopolitical unrest in mineral-rich areas like Africa and South America, and often a lack of reliable infrastructure to boot. Then there’s volatile commodity prices once you bring metals to the market.

But what if you could enjoy the benefits of a precious metals play without the hassle of mining? And what if you could guarantee a low fixed cost on the metal you are trading on the open market — as low as $400 an ounce for gold or just $4.40 an ounce for silver?

That’s just what Silver Wheaton (SLW) offers.

As a “streaming” metals company, focused mainly on silver but increasingly on gold, Silver Wheaton pays miners in advance of future production in exchange for delivery of ore at a low cost down the road. For instance, a miner (which SLW does not own) might need cash to finance a new exploration project, so it takes an upfront payment from the company in exchange for delivery of silver at $4.40 or gold at $400 per ounce — which Silver Wheaton then sells at market value.

And by the way, even after cratering, gold prices are above $1,370 and silver prices are over $22. Those are pretty sweet margins.

“I like to say we deliver all the rewards of a typical mining investment, but we’ve taken the cost risk out of the equation,” Silver Wheaton CEO Randy Smallwood told me in a phone interview Tuesday.

Undoubtedly, commodity stocks have been hit hard in 2013. Silver Wheaton stock is off almost 40% since Jan. 1, reflecting hits for major miners. In gold, Barrick Gold (ABX) is off about 45% in 2013, as is AngloGold Ashanti (AU); in silver, Hecla Mining (HL) and Coeur d’Alene Mines (CDE) are both off about the same.

But as a geological engineer by background, Smallwood has kept his focus on quality miners with low production costs and continues to push Silver Wheaton toward big projects that will pay off by 2015.

I talked with the Silver Wheaton exec Tuesday. I previously published an excerpt about what Smallwood sees in store for precious metal prices amid a strong dollar and how speculators are fueling volatility.

As for Silver Wheaton stock, here’s another excerpt of our interview with more details on SLW itself and what investors should know:

Q: Explain the “streaming” process for investors who might not be familiar.

Streaming is a ways and means of crystalizing the value of a non-core asset — in this case, a byproduct from a copper mine, a lead zinc mine or a gold mine. The byproduct is silver, or in some cases gold from copper or lead zinc mines. What we do is we supply capital up front, and for that we get rights to a percentage of whatever silver or gold is produced from these mines going forward. So the advantage to shareholders or investors into Silver Wheaton is that the costs are fixed. … And then the delivery cost when that silver or gold is delivered to us has a fixed payable rate, a delivery rate per ounce. In the case of our gold mines, it’s typically $400 per ounce. … On an equivalent basis, in the first quarter, our average cash cost per ounce of silver equivalent was $4.40.

Q: Is the deal pegged to CPI?

A: No, some of the very first deals we did were tied to CPI, but what we’ve found is that different jurisdictions and geographies around the world have challenges coming up with good, consistent numbers. Most of our contracts have just a fixed inflation rate of 1% change, arbitrarily, starting in the fourth year of the contract.

Q: It’s been ugly for all commodities lately. What do you hear from your partners in mining about the current distress?

A: There’s definitely distress in the industry, but what our company focuses on is investing in the lowest-cost producers. We focus on the first quartile (Editor’s note: That’s the lowest 25%) of the respective cost curve — so when we look at the copper industry, we look at the mines in the bottom half of the cost curve. … We know those mines will survive low commodity prices, and it’s the high-cost ones that will shut down first and slow down and cut back the supply side of their supply/demand equation. … So in the crisis we had in 2008 and again right now, all of our major operations are still very strong and very profitable and will continue to be so.

Q: What makes a mine lower-cost — big reserves, easy access?

A: Well, the big factor is, of course, grade. Your costs are based on a per ton basis, but your grade is what drives your revenue. If you have higher grades, you’re going to automatically be producing much less because you’re going to be making more for the ore that you process.

Q: What longer-term projects does Silver Wheaton have in the works that hold promise?

Well, the growth that we see in 2013, the bulk of it is going to come from the Salobo mine — a copper mine where we just acquired the gold stream from Vale (VALE) down in Brazil. It’s ramping its way up toward 24 million tons per annum, and so through the course of this year it will be climbing up to 12 million tons per annum.

Most of our substantial growth is going to come next year. We’ve got three projects that are going to be completed in 2014: we’ve got Constancia down in Peru under construction; of course Pascua-Lama, which has a schedule that says it will be completed by the end of 2014; and then Rosemont, which we think will come on by 2015 once they have their permits in pace.

So we do have some pretty substantial growth coming into the company, and that’s going to be the growth of our company for the next few years outside of new acquisitions. This is a market that does very well in terms of making new acquisitions. There’s lots of opportunity out there.

Q: How do you keep your focus on the business amid the media hysterics over precious metals?

A: I focus first on building a very, very strong business. The market is a means of support and a means of measuring our success, but the market is a very emotional space. My belief is that you just focus on building a strong business and the market will follow you. … Obviously our revenue is driven by market prices, but making good strong investments is the way to stay in control of our costs. So business first, and eventually the market will follow.

The current business climate is the strongest I’ve ever seen for new opportunities, and we’re actually excited about making acquisitions to build up that portfolio the company and continue growing the company going forward. It’s a very capital-hungry market right now, looking for sources of capital. With organic growth climbing to 53 million per ounces by 2017, and with most of that by 2015, these next few years are going to be very exciting for Silver Wheaton. Our company is going to have some substantial growth and success all the way across the board.

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Jeff Reeves is the editor of InvestorPlace.com 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, he did not own a position in any of the stocks named here.

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