A Different Way to Invest in Gold

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Investors looking for an alternative way to invest in gold stocks may want to consider gold royalty and streaming companies like Franco-Nevada Corp (NYSE: FNV  ) and Royal Gold (NASDAQ: RGLD  ) . Through royalty and streaming agreements, Franco-Nevada and Royal Gold provide investors with exposure to the upside of commodity price, reserve, and production increases. Because these companies are not generally involved in operational or development management, they can acquire large and diversified royalty and streaming portfolios without large development or administrative costs.

Franco-Nevada 2013 results
Franco-Nevada recently reported year end results for 2013. For the 2013 fiscal year, Franco-Nevada produced 241,000 gold equivalent ounces and achieved oil and gas revenue of $67 million. Total revenues were $401 million while net income was $11.7 million, which included after-tax impairment charges of $114 million . An impairment charge of $107.9 million was recorded on Franco-Nevada's McCreedy precious metal stream as KGHM International Ltd. announced cessation of production of contact nickel ores because its off-take contract has been cancelled.

This impairment charge highlights one of the main risks to gold royalty and streaming companies. Franco-Nevada derived 67% of its 2013 revenues from gold royalties and streams, approximately 13% from platinum based metals, and approximately 17% from oil and gas. For 2014, Franco-Nevada is expecting to receive between 245,000 to 265,000 gold equivalent ounces from its mineral assets and $60 to $70 million in revenue from its oil and gas assets .

New ways to make money
Along with traditional royalty and streaming agreements, Franco-Nevada has recently been expanding into gold royalty and stream financing. This kind of financing provides gold juniors with an alternative to traditional financing that allows them to maximize cash flows and otherwise might not be available to them. In turn, it provides Franco-Nevada with great return potential at low risk. A recent example of this strategy is Franco-Nevada's steam transaction with Terango Gold Corporation. The deal provides Terrango with $135 million which they will use to acquire the balance of the Oromin Joint Venture Group and retire $30 million of debt.

In exchange Franco Nevada receives 22,500 ounces of gold for the first six years of project production and then 6% of production thereafter. Franco-Nevada's purchase price is set at 20% of spot gold and the agreement runs for 40 years. If we do some quick math we can see that over the first six years Franco-Nevada will receive a total of 135,000 gold ounces. Assuming an average spot gold price of $1,300 an ounce, Franco-Nevada would receive roughly $140 million after they paid the 20% spot gold price. Then they would receive 6% of Terango's gold production thereafter. With Terango projecting production of 250,000 to 350,000 ounces annually, this would provide Franco-Nevada with over $15 million annually at the low end of production assuming an average spot price of $1,300 an ounce.

Royal Gold
Royal Gold reported Q2 2014 net income of $10.7 million on revenue of $52.8 million. This compares to net income of $27.2 million on revenue of $79.9 million for Q2 2013. The decrease is mainly attributable to 26% realized lower metal prices and 11% lower production volume subject to Royal Gold's interests. Royal Gold had current assets of $729 million compared to current liabilities of $24.2 million for a current ratio of 30 to 1 as of December 31, 2013. Royal Gold has a credit facility of $450 million, which along with its great cash position means it will have no problem with purchasing new royalties or streams without having to borrow further or raise equity.

Recently, Thompson Creek Metals (NYSE: TC  ) announced start-up production at its Mt. Milligan property. Once Mt. Milligan reaches commercial production, this will be one of Royal Gold's primary gold streams as it will receive 52.25% of the refined gold production at a cost of $435 per ounce. Royal Gold has paid a total of $781.5 million for the stream, but should realize a good reward as production is expected to average 194,000 ounces over the 22-year life of the mine . If we assume a gold price of $1,300 an ounce, Royal Gold is set to receive approximately $87 million per year from this stream. Of course, there is always the risk that production will be less than anticipated or that the mine will prove uneconomical for Thompson Creek and be shut down.

Foolish takeaway
Gold royalty and streaming companies like Franco-Nevada and Royal Gold provide investors with exposure to rising gold prices, but unlike traditional gold miners once the royalty or stream is purchased there are no ongoing operational or development costs. These companies can also benefit from future expansions and exploration discoveries made by the mine operators or developers. One major risk that these companies do face are impairment charges that occur when a royalty or stream stops because a mine is shut down, put on care and maintenance, or shifts focus to mining other materials. 

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  • Report this Comment On March 25, 2014, at 12:55 PM, techpatriot wrote:

    Respectfully, you said in regard's to Royal Gold's TC gold streaming investment:

    : "Of course, there is always the risk that production will be less than anticipated or that the mine will prove uneconomical for Thompson Creek and be shut down".

    I have to disagree. This is not some mineral exploration company that they funded, not is Mt Milligan in the beginning stages of resource exploration or development.

    1) If product is less (or indeed, more) than anticipated, it will be on the order less than +/- 10%. If you read over the geological surveys and the details in TC's 10K reports referring to the Mt Milligan mine, you will see they are consistent, and the technology (geology) behind such information is solid and proven. Also, this is a producing mine now, it is in the middle ramp up phase and the only things remaining to tweak are the mill throughput, and the metal recovery rates.

    Both of these systems utilize 50 to 60 year old proven techniques, enhanced by modern computer analysis and control. And even a +/- ratio of 10% is being overly generous and far too cautious, but it IS FOOLISH lol.

    2) As far as the mine proving "uneconomic", it will be one of the lowest priced copper producers in the western hemisphere, if not the world.

    If copper and gold BOTH slip about 30%, yes, the mine would become uneconomic for TC (but maybe not for a major - so it could be sold).

    However, at those prices, over three fourths of existing copper and gold production out there is also, guess what, "uneconomic" as well! And what is the cure for low metal prices? Low metal prices! Price goes down - supply goes away - price goes up - supply comes back.

    Just look at oil. Would companies be drilling and producing offshore in thousands of feet of water if oil were $50 a barrel instead of $90 a barrel?

    Of course not!

    Oil sands?

    Probably not.

    The only thing that impacts prices in a permanent way are demand and technology.

    It is unlikely that science (technology) will find an economical replacement for copper anytime soon.

    It is also unlikely world population (demand) will rapidly decline any time soon.

    Royal Gold may have some income variability, but it is not likely to have to worry about it's income stream from Thompson Creek's Mt Milligan mine.

    In fact, if you go back and research the NI 43-101 (mineralization) report on Mt Milligan on SEDAR, you will see that that their claim encompasses a much greater area than is currently being mined, and that some drilling has already been done pointing to likely mineralization of the same area as the mine on much of the claim nearly adjacent to the mine. What does that mean? Thompson Creek, some point in the next couple of years, will most probably be able to materially increase the proven reserves at Mt Milligan. Not only will this increase TC's BV and and market value, but you know from reading the streaming agreement that Royal Gold will also get a piece of this, so their streaming income from Mt Milligan should last much longer than the current rated LOM, which will increase Royal Gold's BV as well.....

    Meaning both TC and Royal Gold are probably materially undervalued right now....

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Charles Sherwood

Charles is a long term buy and hold investor who is fascinated with investing and the marketplace.

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