SILVER WHEATON CORP. T.SLW

Doug Casey discusses Wheaton vs. Silverstone

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NEW COMPANY RECOMMENDATION

Wall of Worry fears are not all bad. In fact, they can be great, if they give us

opportunities to buy good companies cheap. We believe that’s the case with

Silverstone Resources (V.SST), a new company following the Silver Wheaton model

of producing pure silver without actually getting into the difficult business of mining. SST

has excellent potential for rapid gains – a good spec for cash recovered on Judgment

Day.

Full disclosure: we recommended this pick a couple weeks ago in a Casey Investment

Alert, after conducting due diligence on the ground in Mexico, but general market

weakness has brought even better entry points, and it’s an obvious match for the

International Speculator.

With high marks on all 8 Ps, this pick does qualify among the best of the best, in our

view, and we’ll be building a position on the dips as they come.

BUY—Silverstone is the silver-focused offspring of Capstone Mining Corp (T.CS), a new

copper producer operating in Mexico. But Capstone didn’t just spin its silver prospects

out to Silverstone, it also sold the new company its silver byproduct stream. They then

followed up with an even bigger move with the Lundins that we’ll tell you about

momentarily, but let’s start with the P’s…

People

Silverstone’s president and CEO is Darren Pylot. He was also the founder of Capstone in

1994, and has the same titles in both companies. Capstone achieved commercial

production at its flagship Cozamin copper mine in Zacatecas, Mexico, in September of

2006 and is generating significant earnings. The fact that so many juniors fail at this

transition tells us a lot about Pylot and his team.

Also on the board is John Wright, who put ten years in with Teck Cominco (NYSE.TCK),

and participated in the building of the Afton, Highmont, Bull Moose and David Bell mines,

among other achievements. However, the main thing that stands out on Wright’s

resume is that he was co-founder of Pan American Silver (T.PAA) with Explorers’ League

honoree Ross Beaty. This is a double recommendation, because we trust Ross’

judgment, but also because of the great success PAA has been – and Wright’s

contribution to that success.

Even though the plan is to focus on growing Silverstone through more silver off-take

deals, the company does still have a portfolio of silver exploration projects on which it is

working, and the man in charge of that is Hugh Willson, VP for exploration. Willson has

30 years of experience as an exploration geologist throughout the Americas, including

stints with Hanna Mining, Getty Minerals, Newmont Mining, FMC Gold, Hecla Mining,

Magma Copper and Cyprus Mining. He was part of the three-man team that identified

the exploration target that became the Peñon Mine in Chile.

On the ground in Mexico, we met several company geologists and were positively

impressed with their knowledge and professionalism. Their preparation for our visit was

comprehensive and highly informative. Ruben Melendez (manager of exploration) was

particularly sharp.

John Wright’s presence on this team gives us a lot of confidence in the overall quality

and character of management, but it is a team, and it’s one with a track record of

success.

Property – Silver Streams

We are big fans of the business model Silver Wheaton developed to “produce” silver

without actually having to put on a hard hat. But it’s more than the convenience of

letting someone else deal with all the headaches inherent in mining. It’s really more like

a royalty and hedge deal: the contracts deliver silver at set prices, regardless of how

high the price of silver goes, or what operating or financial difficulties the source mining

company experiences. The source mines would have to shut down to cut SLW off from

its silver stream – obviously something the producers will avoid if at all possible. Years

from now, when this secular bull market for metals has run its course, stable production

may become a problem, but for now, SLW’s brilliant idea is working very well.

How Silverstone came to adopt a “Silver Wheaton Model” of buying silver production is

rather amusing. Capstone was in the process of spinning its silver assets out into

Silverstone (because the market wasn’t giving CS any credit for them) when it tried to

sell the silver byproduct of its new Cozamin copper mine to Silver Wheaton. SLW

declined, so management thought, “Why don’t we do it ourselves?”

Why not indeed? One answer might be that the Capstone-Silverstone deal could seem a

bit incestuous, a shell game with management paying itself, and that might make it

difficult to close any more deals. Capstone got an up-front payment of US$20 million

from Silverstone’s new shareholders, and US$24 million in the form of 19.2 million

special warrants exercisable at no further cost. In addition, of course, it gets US$4 per

ounce of silver produced for SST. CS still holds about 20% of Silverstone’s shares and a

few of the special warrants it was issued. In exchange, Silverstone basically has the right

to 100% of Cozamin’s silver production (1.3 to 1.5 million annual ounces of silver) for

ten years. The average per-ounce price, including the up-front payment, is near $8/oz,

but SST only pays $4/oz on an ongoing basis, generating about $14/oz in cash flow at

current prices.

As it turned out, Silverstone was able to find others willing to cut a silver off-take deal,

starting with Lundin Mining (NYSE.LMC, T.LUN), which agreed last September to sell SST

100% of the silver production from its Neves Corvo and Aljustrel mines in Portugal. Both

of these are Life of Mine (LOM) deals, with between 600,000 and 900,000 annual ounces

of silver over 15+ years from Neves Corvo and 500,000 to 1,500,000 annual ounces

over 10+ years from Aljustrel. SST paid US$42.5 million in cash and 19.6 million in

shares. Silverstone also pays US$3.90 per ounce of silver produced, making total

payments still in the neighborhood of $8/oz.

For context, Silver Wheaton started out paying $3.90/oz back when silver was around

$6.75/oz, but now also makes up-front payments as well as the now-traditional $3.90/oz

ongoing payments. In SLW’s most recent deal (with Mercator Minerals), the up-front

payment of $42 million plus the $3.90 per ounce work out to an average per-ounce price

of $7.23. For a new entrant in the field, Silverstone’s deals are not bad at all.

Last February, Silverstone announced a different kind of deal with Aquiline Resources

(T.AQI) for a portion of the silver produced from the latter’s hard-won Navidad project.

The deal is rather complicated, but this is necessary as Navidad still has a long way to

go before becoming a mine. To mitigate the risk inherent in buying the silver so early,

SST structured the deal in the form of a debenture that is convertible either into AQI

shares (which could be sold to recover the cash at some gain or loss) or 12.5% of LOM

silver production from the Loma de Plata zone at Navidad.

Why only 12.5%? Because this isn’t a little silver byproduct from a base metal mine, but

silver off-take from a big chunk of a world class silver project. Aquiline’s November 2007

resource update on Loma de Plata included 9.1Mt at 225 g/t silver (66 million ounces

silver) Indicated and 17.3 Mt of 159 g/t silver (89 million ounces silver) Inferred. That,

by the way, is within the larger Navidad resource of 127.7 Mt grading 110 g/t silver and

1.06% lead (453 million oz Ag) M+I and 49.0 Mt grading 97 g/t silver and 0.5% lead

(153 million oz Ag) Inferred. Drilling continues to expand these resources.

The convertible debenture was a very smart way to jump on a developing silver stream

early while minimizing risk. This and the high-profile Lundin deal show that Silverstone

can indeed implement the “Silver Wheaton” model. We expect to see more growth along

these lines, but even if it takes a while, growth from the already producing silver

streams is turning SST into a cash cow. During the first eight months of 2007, SST sold

$2.6 million worth of silver but lost $2.1 million. But during the final four months of

2007, SST saw its attributable production more than double, from 214,000 ounces of

silver through 8/07 to 524,000 for 9/07-12/07. Sales jumped to $7.6 million, and the

loss turned to earnings of $1.2 million.

And that’s just the beginning. The company projects just over two million ounces of

silver produced this year, just over three million next year, and about 4.5 million by

2011 – without any new deals being signed.