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Will Silver Wheaton Deal With Vale for Salobo Gold Mine Pay Off?

NEW YORK (TheStreet) -- Silver Wheaton (SLW - Get Report), the world's largest silver (SLV) streaming company, hasn't entered into new streaming contact in over a year. The last big streaming agreement was in February 2013 with Vale (VALE). Under this agreement, Silver Wheaton will acquire a quarter of the yield from the Salobo Mine's in Brazil for the life of the mine, and 70% of the gold output of Vale's Sudbury Mines in Canada for 20 years.

This agreement looked much better in early 2013, when gold (GLD) prices were at $1,600 per ounce. But the low gold prices have made this agreement less profitable for Silver Wheaton. Tuesday, gold was trading at $1,288 an ounce.

So what do investors need to know?

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Since the Salobo Mine is the bigger-producing mine, let's use it to see the potential profit or loss this contract offers to Silver Wheaton. For the mine's output, Silver Wheaton paid $1.33 billion. In exchange, the company will receive gold streaming for the life of the mine (let's say 30 years) at a very low cost of $400 per ounce of gold (with 1% annual inflation).

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Up to the end of the first quarter of 2014, Silver Wheaton sold a total of 27,000 ounces of gold and has an attributed production of 38,000 ounces of gold from Salobo.

At the end of last year, the mine's proven reserves -- the amount of metals estimated with reasonable certainty from the analysis of geologic data -- were over 2.1 million ounces of gold. Moreover, Vale plans to ramp up production capacity by 2016.

Based on these figures, Silver Wheaton should receive over 30 years an average of 70,000 ounces of gold starting in 2016, as indicated in the table below.

Source of data: Silver Wheaton's Web site

You can also see the cost of one ounce of gold will reach $534 by 2045 under the 1% annual inflation.

But the current price of gold at under $1,300 puts this investment in the red. Under a very generous discount rate of 5% (for precious metals mines the industry average is 8.5%), the present value of the net cash stream comes to $985 million.

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