Continued currency debasement and rising gold prices multiply the potential upside for gold miners, but large-cap royalties and streaming companies should be considered first on your list of investments for one seeking professional risk-management of a precious metals portfolio. These companies employ mining engineers, metallurgists, geologists and financial consultants and are often referred to by analysts as the “smart money” of the gold industry.
Versus miners, royalties and streaming companies see more growth as a percentage of production and more upside for every dollar invested. In addition, metals streamers expect sustained growth in the coming years as the gold industry continues to consolidate on diminishing mine yields. The majors are suffering…
“Whereas gold miners found about 1.4 ounces of gold reserves and resources for every ounce produced between 1990 and 1999, the rate has dropped to about 0.3oz of gold found for every ounce produced,” according to S&P Global Market Intelligence.
What Are Gold Royalties & Streaming Companies?
Rather than directly mining and drilling for metals themselves, royalties and streaming companies serve as specialized lenders to explorers and producers, especially in the case where deals can be made for by-products of a producers primary mining activities. Royalties and streaming companies allow these miners to reduce debt, expand and build new mines, and monetize their assets.
In exchange for the money the company provides, the royalty and streaming company acquires rights that allow the company to share in the success of its news partner, the borrower. These rights take form as either royalties or streaming rights.
Royalties and streaming companies run lean. Typically, they are able to lend cash to other projects by raising funds through stock issuance. This means that strong management is required in order to prevent dilution of current shareholders, with cash put to work to produce ROI, expand business operations, and improve shareholder value through capital growth and increased dividends.
Some popular royalties and streaming companies include:
What Are Gold Royalties?
Basically, gold royalties are rights owned by the royalty company, the lender, to a percentage of all future sales the borrowing miner makes during the life of the mine. The miner gets funding, and the royalty company gets a little taste of the mine, forever.
Types of royalty deals seen in the mining industry include, but are not limited to:
- Gross Smelter Return Royalty: A defined percentage of the gross revenue from a mine, less deductions.
- Milling Royalty: A royalty on ore throughput at a mill.
- Production Royalty: This is also known as a Fixed Rate Royalty and is seldom negotiated because it provides a fixed payment per tonne of production, with no consideration to increases or decreases in market prices or operating costs.
- Net Smelter Return: Sometimes called Gross Revenue Royalties this type is common in the mining industry and is based on the value of production, or net proceeds, received from a smelter or refinery.
- Royalty in Kind: This gives the holder the rights to take delivery and/or purchase a percentage of future mining production, which is most common in streaming agreements.
What Is Gold Streaming?
The second way for royalties and streaming companies to leverage their special financing powers is via a purchase agreement that gives the company the right to purchase metals produced by a mine at a predetermined price. The miner gets funding, and the streaming company gets to hedge against downside price movement in precious metals, while patiently waiting for higher prices with most of the risk taken by the miner.
Metal stream acquisitions are often larger in size than royalty acquisitions, have more flexibility in the negotiation of terms and conditions, and generally provide both parties with tax advantages.
Armed with an understanding of what royalties and streaming companies are, let’s now dig into the benefits and advantages of this business model. Once understood, this author believes readers will begin to consider royalties and streaming companies for further DYOR.
Advantages of Gold Royalties & Streaming
“Juxtaposed against miners scrambling to replace mined-out reserves, the metals streamers are looking towards unrivalled production growth at low costs in the coming years. With growing free cash flows, they are on the prowl for accretive deals. This sector’s risk-off business model is demonstrating sustainability and organic growth opportunities not seen elsewhere in the mining industry.” – Mining Journal, October 2018
Today’s tight credit and debt markets give royalties and streaming companies a strong position in negotiating new royalties. Junior exploration and production companies are in need of regular financing, while recent years haven’t been kind to stock prices. This is huge for royalties and streaming companies. Beyond global macroeconomic conditions creating an opportune moment for investing in these types of companies, though, there are evergreen advantages for royalties and streaming companies.
Advantages of royalties and streaming companies can be considered as falling into three categories:
- Diversification
- Upside potential
- Limited downside risk
Diversification
Diversified commodities portfolio: A streaming company has agreements with multiple miners and multiple streams of income, with the large-cap royalty and streaming companies providing exposure to hundreds of mines and investments at all stages of development. In addition, large-cap royalty and streaming companies don’t limit themselves to gold. They diversify into diamonds, silver, copper, and even energies such as oil. Understanding the gold and silver prices are volatile, diversification of income streams also mitigates downside risk and possible disruption of business growth.
Diversified markets: Emerging markets such as South America and Africa are the primary mining markets for metals producers. Emerging and frontier markets are rich in precious metals, so it would come as no surprise to find major precious metals producers having exposure to the geopolitics and currencies of those regions. Clearly, the advantage here for royalties and streaming companies is that they can mitigate geopolitical and currency risk through diversification. Beyond that, though, emerging markets exposure is important for one’s personal investment portfolio, so perhaps royalties and streaming companies can be considered for this “slot” rather than an emerging market etf.
Upside Potential
Optionality! Royalty companies receive an option on all future exploration and potential growth at no additional cost. Why is this important? Well, mineral deposits are often larger than expected. As drilling reveals new resources, mine life is often extended and/or production increased. Don’t forget… royalty deals secure a percentage of the mine’s production for life.
Locked-in low prices, low costs, wide margins: In the world of precious metals, low-cost producers dominate the industry. Royalty and streaming companies are the low-cost leaders. They buy gold and silver at reduced prices, while having near-zero costs relative to the miners with which they partner, creating a wide moat of margins for investors to enjoy. It’s important to note that this business model, because of the above, provides a level of precious metals bear-market resistance.
Limited Downside Risk
Limited production risk: While a miner may see profit margins squeezed as the cost of production rises, the streaming company typically has a contract for a percentage of the gold/silver production, thus eliminating the issue of rising costs. Not only that, but royalties are taken off the top of production from mine operators. How ‘ya like ‘dem apples?
Limited mine risk: Royalties and streaming companies see little exposure to always increasing mine operating costs. These companies also avoid a slew of mine risks, such as work stoppages and mine disasters. The mine grows, needing more workers? That’s on the miner. Mine collapsed and there’s a huge lawsuit? That’s also on the miner. The royalties and streaming business model limits much of the legal and geopolitical risks coming from mine exploration and production.
Final Thought:
One major argument against owning gold is that gold doesn’t pay dividends… it doesn’t earn money for an investor while he’s sleeping. I’d be remiss in my duties if I forgot to mention that royalties and streaming companies typically reward investors with dividends. Of course, the dividend depends on the company, with large-caps having a more established dividend history.
Gold exploration and production is both a high-risk and high-cost business venture. At the same time, the largest share of wealth creation from the resource sector comes from new discoveries. Gold royalties and streaming companies are able to benefit from new discoveries while mitigating geopolitical risk and eliminating the huge costs associated with metals mining. Rather than picking a junior miner or micro-cap exploration project for your portfolio, consider instead the large-cap royalties and steaming companies.