- Gold streaming companies carry much less risk than a miner thanks to lower costs and better diversification.
- However, these companies are still exposed to exploration upside and benefit from higher commodity prices.
- Most of them even pay a dividend.
Central banks will continue to print money even if it looks like they are taking a breath now. Therefore, gold investing still remains an important hedge for every portfolio. A hedge that is even cheap if gold prices are at a subdued level.
Figure 1: Gold prices since 1971 and the M2 money stock. Source: FRED.
What’s clear from the figure above is that gold prices follow the amount of money in the environment but not with perfect correlation. Sometimes, as was the case in 2011 with quantitative easing policies, people get excited about gold while sometimes people are not that excited (2015-1016). Nevertheless, the long term trend is pretty clear and as the FED, ECB, PBOC, BOJ, and others constantly repeat that they’ll do everything it takes to keep their economies running smoothly, we can be assured that there will be plenty of monetary easing in the next decade. This will most definitely lead to much higher gold prices and I wouldn’t exclude gold going to $3,000 and above per ounce in the next 10 years.
However, it’s impossible to time gold price movements and recessions. If things continue to go well in the economy and in Europe, central banks will trim their balance sheets and interest rates will increase, and gold prices could easily go below $1,000. As with every other investment, risk always has to be kept in mind.
In today’s article, we are going to analyze gold royalty companies which offer an interesting risk reward portfolio exposure to gold.
What Are Precious Metals Royalty, Or Streaming, Companies?
A gold royalty or streaming company is a company that helps finance the exploration or production projects of the usually cash-starving development miners in exchange of receiving a royalty or future stream once the project is in production.
Figure 2: How precious metal streaming works. Source: Wheaton Precious Metals.
For example, Wheaton Precious Metals (NYSE: WPM) bought 25% of all future silver production at a price of $3.9 per ounce from the Penasquito mine from Goldcorp (NYSE: GG) for $485 million in cash back in 2007. That money allowed GG to lower its risk in relation to mine construction but cost them a high percentage of future silver revenue while they kept the gold revenue.
A royalty would be a deal structure where the financing company simply receives a percentage of the revenue.
Nevertheless, a company like WPM has a fixed cost for its silver and gold production while it has upside potential coming from increased production at the mines it has invested in.
Figure 3: The low-cost base for WPM, a common thing for royalty companies, with a gold cost $400, and silver at $4.71. Source: Wheaton Precious Metals.
The low cost per ounce is what makes royalty companies an attractive investment as that will generate cash flows even with weak gold or silver prices.
The Benefits Of Investing In Royalty Companies
The benefits of investing in royalty companies are pretty simple:
- You’re exposed to the upside in commodity prices as the margins increase with higher gold or silver prices.
- There’s no additional costs risks, no capex. Mining is a pretty complex activity and additional costs are always around the corner. However, royalty companies always pay the agreed amount for their ounces, no matter the difficulties incurred by the miner.
- You’re exposed to production increases at no cost. If a miner increases its production rate, the streaming company will receive more cheap ounces as it gets a percentage of production.
- A royalty company has no exploration costs as all the exploration is done and paid for by the miner.
- If a mine increases its mine life, the benefits to the streaming company are exponential as the company practically hasn’t paid for the increased mine life while it is still entitled to receive the benefits as long at the mine is operating. A perfect example is Royal Gold (NASDAQ: RGLD) which can thank most of its success to the Cortez mine in Nevada.
- As such companies enjoy large positive cash flows, a dividend is in their DNA. So if you want to own a miner that’s paying a dividend, royalty miners are for you.
- A royalty company usually invests in several projects, so the risk inherent with investing in a specific miner, be it political or otherwise, is well diversified.
The risks of investing in royalty companies:
- Although royalty companies are well diversified, if they invest a significant amount of money in the initial stages of mine development and the mine is not put into production, all the money is lost.
- A royalty company depends on the quality of its miners who assess investment projects. If the company overpays for future streams, the return on investment can be negative.
- In order to invest in as many investments as possible, a royalty company might be incentivized to take significant amounts of debt which can’t be financed in case of lower commodity prices. Therefore, always check interest rate costs before investing in a royalty company.
- Negative commodity price movements will also have a negative impact on royalty stock prices. Perhaps less than with actual miners, but still negative and more volatile than actual gold prices.
- Good gold royalty companies don’t come cheap.
Top Precious Metals Royalty Companies
Franco Nevada Corporation (NYSE: FNV)
FNV is the largest royalty commodity company with a market cap of $14 billion. It owns gold royalties in 41 producing assets, 34 advanced projects, and 135 exploration projects in addition to 80 oil and gas projects.
Figure 4: FNV’s diversification. Source: FNV.
A look at the U.S. exploration royalty assets for FNV will show how diversified the company is.
Figure 5: FNV’s U.S. exploration royalty deals. Source: FNV.
On top of everything above, FNV has no debt however it does come at a hefty price with a price earnings ratio of 99 and a price to cash flow ratio of 28.6. Nevertheless, there is a dividend yield of 1.14%.
The future for FNV is definitely clear, especially as the advanced projects get closer to production.
Wheaton Precious Metals (NYSE: WPM)
WPM isn’t as big as FNV, but it is cheaper with a price to earnings ratio of 36.68 and with a dividend yield of 2.18%. However, the ratio of producing assets to development projects is much higher than with FNV with 20 operating mines and only 9 development projects.
Figure 6: WPM’s portfolio. Source: WPM.
Royal Gold (NASDAQ: RGLD)
I’ve already mentioned that RGLD can thank its success to the Cortez mine in Nevada. Nevertheless, the dividend yield is also low at 1.1% and the price to earnings ratio is 55.3. It’s important to note that the company only has 22 employees which is something normal for royalties. Talk about keeping costs low.
The three gold royalty companies mentioned above have all outperformed gold, both in the long term and in the short term. This is important because from 2005 to 2011, gold prices had been rising while since 2012, gold prices have been declining.
Figure 7: Comparison of gold and gold royalty companies since 2005. Source: Nasdaq.
Since 2012, only WPM hasn’t outperformed gold.
Figure 8: Comparison of gold and gold royalty companies in the last 5 years. Source: Nasdaq.
Investing in royalty companies means investing in gold and getting a dividend while running lower risks than you would with a specific miner. Nevertheless, you still get exposure to the upside in commodity prices, diversification, and potential from exploration. From all of the above and from knowing that central banks will continue to print money in the future in order to keep interest rates low, a risk averse investor that likes dividends should really look into royalty and streaming companies.
Keep reading Investiv Daily as I’ll soon make a detailed comparison of the largest gold miner, Barrick Gold, and FNV in order to determine what kind of a gold investment is the best exposure to your portfolio, whether a gold miner or a gold streamer.