We tend to think there are two means by which to invest in gold. Via the metal – coins, bars, futures and so on – or via a company that mines it. The metal is the safer option, but (assuming it all goes right, which often isn’t the case) you make greater returns with the mining company, though with greater risk.
There is a third way. In terms of risk, it stands somewhere between metal and miner: the royalty company. And this is the option I’d like to consider today.
What is a royalty company anyway?
Let's start by explaining what a royalty company is. Building a mine is extremely expensive. It takes a lot of capital and a lot of time – extraordinary amounts. From exploration, through development and construction, to actual production, can take many years and hundreds of millions, sometimes billions of dollars in capital.
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The traditional way to finance a mine is through borrowing money or issuing equity. Borrowing the money you need to build a mine can be problematic and restrictive. Cheap debt can be hard to come by, especially in bear markets. Too much debt or delays in its repayment can be destructive. Debt has brought down many a mining company. The other means to finance a mine – issuing shares – has its own set of problems, not least that it can be extremely dilutive to existing shareholders.
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Enter the royalty company. In exchange for a share of the mining company’s eventual production – a royalty – the royalty company will provide the funding that the mining company needs. That share of production or royalty might take several different forms. Once the mine is producing, the royalty company might receive a percentage of that production at a pre-determined price – either a set price or at a percentage discount to the gold price. The royalty company can then sell that gold at market rates, and thereby make its profit. This would be a streaming contract. Around 75% of royalty deals are streaming contracts.
Alternatively, the mining company sells its gold directly into the market and then writes the royalty company a cheque for its share of the revenue or profit. This would be a royalty deal. A share of revenue would be an NSR – net smelter return. A share of profit would be an NPI – a net profits interest.
From an investment point of view there are many reasons to like royalty companies. With prices for mining output already set, they can still make money even when the gold price is falling. They don’t operate mines themselves, and so the huge infrastructure and operating costs do not fall to them. They take on lower levels of debt than producers. Their staff costs are low. A mine might employ hundreds of thousands of people, royalty companies have no such burden.
Wheaton Precious Metals (LSE: WPM) is among the largest royalty companies in the world. It is listed in London, New York and Toronto. Its market cap is around US$20bn. It has just two offices and fewer than 40 employees. Its third quarter revenue, announced just yesterday, was US$307m. That works out at an annual rate of over $30m per employee. I wonder if there are many companies in the world that generate that kind of revenue per employee. Even tech companies would struggle.
Royalty companies can pick and choose their projects, so they can avoid dodgy management, jurisdictions or mine economics, if they so choose. They hold diversified portfolios and so minimise the concentration risk you find in a mining company that is dependent on its projects alone, which might amount to just one or two properties. In the event that one property goes wrong, the royalty company has other contracts to fall back on. Some royalty companies will diversify by owning streams on other metals, even on oil.
Royalty companies have done a lot better than miners
I’ve often uttered frustration on these pages that mining companies have so underperformed the metal when they are supposed to outperform it. No such complaint can be made about royalty companies. Though the model is relatively young – human beings may have been mining gold for thousands of years, probably since before the dawn of civilisation, but the first royalty company came into existence in 2004 – royalty companies have outperformed metal and miner in both bull and bear market.
Over the last ten years we have seen both bull and bear markets in gold. Ten years ago gold was $1,350 an ounce, so today it’s trading about 40% higher. The HUI – the index of unhedged gold miners – on the other hand, is about 40% lower. Junior miners, as represented by the VanEck Vectors Junior Gold Miners exchange-traded fund (NYSE: GDXJ), are more than 50% down.
Now let’s look at four of the largest gold royalty companies (chosen for no other reason than that they were the first ones that came to mind) – Franco Nevada (NYSE: FNV), Royal Gold (NYSE: RGLD), Wheaton Precious Metals (NYSE: WPM) and Sandstorm Gold (NYSE: SAND). Franco Nevada is up over 400% since 2010, Royal Gold is up over 150%, Wheaton Precious Metals is up 50% and Sandstorm is up over 100%. Remember that includes the 2012-2016 period, which was one of the most vicious precious metals bear markets ever known to man.
There are many royalties companies to choose from in the space, as well as the above-mentioned large caps. Wheaton Precious Metals has a London listing, but to buy the other large-cap operations you’ll need to venture across the pond (or your broker will). Canada has a plethora of small and mid-caps in the space. Consider Metalla Royalty and Streaming (Vancouver: MTA), Elemental Royalties (Vancoucer: ELE) and Nomad Royalty Company (Toronto: NSR). Of these, at current prices, my favourite is Elemental and, disclaimer, I own shares in that one.
The small cap space in London has a couple of other options, if you prefer this side of the water. Trident Royalties (Aim: TRR) is one – market cap around £30m. I must confess I don’t know the company – I only discovered it while researching this article.
Finally, there’s another company in which I own stock and have mentioned on these pages before: Altus Strategies (Aim: ALS). Altus has projects all across Africa – something like 20 different projects and nine royalties – and is so undervalued as to be verging on the extraordinary. Its Mali projects alone more than justify its current £35m market cap. One day the market will give it the valuation it deserves.
Daylight Robbery – How Tax Shaped The Past And Will Change The Future is now out in paperback at Amazon and all good bookstores with the audiobook, read by Dominic, on Audible and elsewhere.
