Unless you're already invested in a gold streaming company, you might not be familiar with the industry or its business model. The term gold streaming describes a financial transaction in which a company provides cash up front to a mining company for the right to buy gold at reduced prices in the future. For investors, it is a very different way to add gold and precious metals exposure to your portfolio, and one that comes with a lot of benefits. Once you get a better handle on what gold streaming is, you'll likely agree that buying stock in a streaming company is probably one of the best ways to invest in gold. Here's what you need to know.
How is streaming different from mining?
A mining company finds a place where it believes there's gold, builds a mine, digs up the gold, and sells it. That's obviously a vast oversimplification of a very complex, time-consuming, and expensive process, but it covers the high points. Complicating this process is that gold is a commodity that trades based on supply and demand, so a miner's revenue and income tend to fluctuate along with the often volatile price of precious metals. Fast-moving commodity prices are a big headache at times, since mining costs, like salary expenses, don't change as quickly as investors' gold whims. It's a business that frequently alternates between feast and famine.
Streaming companies don't get their hands dirty trying to operate mines. Instead, they provide cash to miners to help them run their businesses. An agreement between a miner and a streaming company can be reached at any point, from a mine that's still only on the drawing board to one that's already producing. It's a completely financial transaction -- an important distinction, as you'll see below.
A brief history of streaming
Streaming, however, isn't all that unique: The oil and gas industry has used a similar model for a very long time. The model wasn't really used in precious metals mining, however, until the 1980s. Franco-Nevada Corp was among the first in the space, and the idea was something of an "aha!" moment, according to current CEO David Harquail in an interview with Mining.com. At the time, Franco-Nevada was using the royalty model in the oil space, and management found itself asking, "Why was no one collecting royalties on the mining side of the business?"
The success of the model over time has led to a huge uptick in streaming deals. There are a handful of public streaming companies and royalty companies at this point, but you'll also find pension funds, private equity groups, and hedge funds in the space. Streaming, meanwhile, isn't unique to gold; the model is used for silver, copper, and a host of other precious and semi-precious metals. (There's even a Canadian company that's using the streaming model in the agriculture market.) Most gold streaming companies have exposure to other metals, most notably silver.
How the streaming business model works
Although every streaming agreement is unique and subject to specific terms, the basic approach is roughly the same across the industry. The deals are tied to the production of a specific mine. The streaming company provides cash to the miner, who agrees to sell the streaming company gold, or some other commodity, at a preset below-market price in the future. The amount can be a percentage of the spot price or an actual dollar figure.
Streaming companies generally use short-term debt, such as bank loans, to cover the initial expense of a streaming deal. They then sell debt or issue stock to permanently finance the deals. More conservative streaming companies, however, may actually raise capital in advance of deals, using the cash over time.
If a streaming deal is in support of a mine in development, the payments from the streaming company may be spread out over time and include milestone targets for the miner. Every streaming deal is different, but the streaming company generally won't receive any precious metals until that particular mine starts operating. If the deal is in support of a mine that's currently operating, then the miner delivers the commodity in question to the streaming company according to the particular terms of the agreement. Once the commodity is delivered, the miner will be paid for it at the agreed-upon price, rather than the current spot price.
At this point, streaming companies then sell the gold to generate revenue. In practice, however, many streaming companies choose to keep some gold in reserve. That said, there's also potential lag time between delivery and sale that can leave streaming companies with unsold gold at the end of any given quarter. Selling less gold than is available to be sold can help smooth out performance over time, providing a cushion in case streaming partners face production shortfalls, or allowing for additional gold to be sold if commodity prices falter.
The benefits for gold miners
It's important to understand that these deals are quite beneficial for miners. The key here is that gold streaming companies provide an alternative form of financing for miners beyond relying on banks or capital markets. Those sources of capital may not provide advantageous terms when miners need cash, and sometimes aren't available at all. Streaming agreements enable mining companies to:
Reduce debt. During the deep downturn in the commodity market that started in 2011 and lasted until 2016, miners often used cash from streaming deals to reduce debt. Downturns like that one are actually quite common in the industry, since it's highly cyclical, but they always seem to catch miners flat-footed and overleveraged. Supply and demand are what drive commodity prices over time, pushing the industry between phases of debt-funded (over)expansion and contraction. Few are willing to provide capital to miners during the downside of the cycle, leaving streaming companies an open field.
Build a new mine. Streaming deals are also valuable when a miner is developing a new mine: It gets the cash up front but doesn't have to deliver any gold until the mine is up and running. That helps keep leverage lower than it otherwise would be if the company took on bank loans or sold debt. It also eliminates the dilution that selling stock to raise capital would cause its investors.
Expand an existing mine. When a streaming deal is used to fund a mine expansion, the miner will likely have to start delivering the gold immediately. However, the miner will get the benefit of the large up-front payment from the streaming company that it can use to fund its expansion efforts. As when building a new mine, using a streaming deal in this way can help keep debt off the balance sheet. That's a key consideration in an industry that's capital intensive --requiring large up-front costs to build and expand mines before the spending produces any benefit.
Monetize an asset. Often, companies ink streaming deals for metals that are merely by-products of other mining efforts. For example, many copper mines also produce gold because the two metals are often found together in nature. A copper miner, however, won't necessarily consider gold core to its business. In this situation, the copper miner may use a gold stream to immediately monetize the asset. Effectively, it is selling the gold over time, but getting a cash payment up front. If it simply sold the gold as it was mined, it would take years to see the financial benefit.
The benefits for gold streamers
In turn, streaming agreements enable streaming companies to:
Lock in wide margins. The biggest benefit for streaming companies, of course, is that they get to buy gold and silver at reduced prices. This locks in wide margins no matter what is happening in the commodity market.
A key measure to watch here is EBITDA margins, which looks at earnings before interest, taxes, and depreciation expenses when examining how effective a company is at turning sales into profits. Interest and depreciation expenses can be large in the mining space and potentially obscure otherwise strong results. Miners, however, often see EBITDA margins fall into negative territory during downturns because they can't adjust their costs fast enough to offset falling commodity prices. Streaming companies don't have to worry about this because their costs are low and often tied to a percentage of spot prices.
Avoid the risk of running a mine. Wide margin, however, is only one of the many positives afforded by the streaming model. For example, streaming companies don't actually operate any mines, which saves them from the risks and complications inherent to the mining business. A great example is rising labor costs, which can crimp a miner's margins but generally have no impact on a streaming company's contractually agreed-upon purchase prices. Mining costs like this often rise when commodity prices are heading higher. This is why the wide margins that streamers generate are so stable over time, but it is also one less thing for a streaming company's management team to have to worry about.
Other mining risks that streamers avoid include things like work stoppages, mine disasters, and dealing with unexpected geologic conditions (lower grades of gold, for example). Events like these, which are fairly typical in the mining industry, may result in reduced mine production or even a complete mine stoppage. That, of course, would impact the flow of gold to streaming companies. However, a streaming company doesn't have any obligation to add capital to deal with such situations -- its up-front cost was preset and prepaid.
Diversify. Most miners have a handful of operating mines at any given time. That makes sense given the cost and complexity of owning mines. But streaming companies are simply making financial investments backed by gold and silver production. They don't need to limit themselves to just a handful of investments. Some streaming companies, in fact, have hundreds of streaming deals across the spectrum, from already-producing mines to assets in the early stages of development. This allows streaming companies to operate a far more diversified business than miners -- and with streamlined corporate structures, since there's no need to have a huge employee base to operate the assets in which they invest.
Risks of the streaming business model
It is probably best to think about gold streamers as specialty finance companies that get paid in gold. Their investments are effectively a portfolio meant to provide current returns from active mines and future returns as development projects bear fruit. Balancing those two factors is management's main goal.
Looking at streamers as finance businesses, however, requires that investors think about a streaming company's capital structure. As noted above, a key part of the streaming model is to use short-term debt to ink the streaming deals. To permanently finance those deals, the streaming company will then issue stock or sell longer-term debt. Stock sales can lead to shareholder dilution if streaming deals don't live up to expectations, which is something to keep an eye on. This can happen for any number of reasons, including mines that simply never get past the drawing board or mines that don't produce gold at the rate initially expected.
On the debt front, meanwhile, there are other things to watch. For example, some streaming companies focus on keeping debt to a minimum, while others are more willing to use debt to fund their growth. Debt is, indeed, a valuable tool for streaming companies, but too much can limit their ability to invest in future deals, creating a major competitive disadvantage. Too much debt can also weigh down current performance as interest expenses eat into profits and increase the risk that production stoppages at mine investments can cause financial stress. You never know when a mine strike or inclement weather can cause business disruptions. While streaming helps avoid many of the risks of mining, if there's no gold coming out of the ground, there's nothing for a streaming company to buy.
Gold streaming companies to invest in
As noted above, there are a lot of players in the streaming space today, many of which are private. The model isn't unique to U.S.-listed companies, either. However, for most investors, it's probably best to stick to some of the largest, most liquid, and best-known names in the space that trade on U.S. exchanges. Below is a list that should provide a good starting point for further research.
|Company||Market Cap||Dividend Yield|
|Franco-Nevada (TSX:FNV)||$13 billion||1.3%|
|Wheaton Precious Metals (NYSE: WPM)||$9 billion||1.7%|
|Royal Gold (NASDAQ:RGLD)||$6 billion||1.2%|
|Osisko Gold Royalties Ltd (NYSE:OR)||$1.6 billion||1.6%|
|Sandstorm Gold Ltd. (NYSEMKT:SAND)||$872 million||N/A|
Is investing in gold streaming companies safe?
If you've read this far, you should have a better understanding of the pros and cons of gold streaming and of the companies that put streaming at the core of their business models. But you might still be wondering if gold streaming is a safe investment. The answer is: Yes and no.
Streaming has shown itself to be a safe way to invest in gold. So, if you're looking to add gold to your portfolio, you should include streaming companies in the mix of options you are considering.
Gold, however, is a volatile commodity. Like it or not, the revenues of streaming companies and the prices of their stocks are going to be impacted by the variations in the price of the yellow metal. There's little that can be done about that. In this regard, you have to look at streaming companies as risky. That, however, is no different than any other gold investment you might make.
Dividends: A side benefit for income investors
The wide margins that the gold streaming business model provides help protect streaming companies' bottom lines and allow many of the largest of them to pay dividends to their shareholders. Although many large gold mining companies also pay dividends, those can end up getting cut when gold prices fall or if company-specific mining issues cause results to falter.
Royal Gold and Franco-Nevada, meanwhile, have each increased their dividend for 10 or more years. And while Wheaton's dividend is variable, the math behind it is preset: It pays shareholders 30% of the average cash generated by operating activities over the previous four quarters. As such, there are no surprise moves by the board of directors.
Reliable dividends give investors something to watch other than stock prices when gold stocks are out of favor. That, in turn, helps soften the emotional impact of stock price drops and makes it easier to stay invested through the down spells to benefit from the upturns.
Best of both worlds for investors?
Some investors might like the idea of owning physical gold coins or bullion. Not only is gold a diversifying asset, but physically owning it means you can use it in the event that global economic systems based on fiat currency break down and we resort to gold as a medium of exchange. At this point, that doesn't appear to be a highly probable scenario. As such, a gold exchange traded fund, or ETF, will be a better option for most investors. For a low fee, these securities provide the diversification benefit of gold and are easily traded (and you don't have to find a place to hide all your gold!).
However, physical gold and gold ETFs don't provide any upside from the exploration process: An ounce of gold today will be the same ounce of gold tomorrow. This is a key reason that investors often favor owning stock in mining companies over owning gold directly. To put it simply, a successful new mine or mine expansion can materially increase the value of a mining stock. On the other hand, miners generally face high operating costs and highly variable commodity prices, and usually only operate a handful of assets at any one time.
That's why investors should consider gold streaming companies like Franco-Nevada, Wheaton, and Royal Gold. Streamers' costs are limited to their initial investment, they avoid operating mines (and the associated risks), they have widely diversified streaming portfolios, they benefit from production growth at the mining assets in which they invest, and they still provide exposure to gold. Add in the dividends offered by the larger streamers, and streaming looks like it might be the best way to invest in gold.