Gold stocks tend to be pretty volatile, particularly if you delve into the smaller miners. But it doesn't have to be that way if you step back and consider all of your alternatives in the precious metals space. Royal Gold (RGLD 2.70%) and Wheaton Precious Metals (WPM 2.23%) are two gold stocks that do things a bit differently, a fact that makes them worth a close look in 2022 and beyond.
The basic precious metals model
If you want to get gold out of the ground, first you need to find a place with enough gold. Then you have to get approval to build a mine (no easy task given the environmental effects of a mine). You have to finance and construct the mine, and then you have to run it. Although this is an oversimplification of the process, not a single step here is at all simple or cheap. In fact, even after a company has a successful mine, there are still material risks, including variable ore grades, mine accidents, and work stoppages, among many others.
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Then there's the not-so-subtle fact that precious metals are commodities prone to material price swings. Given the high cost of operating a mine, a material price decline can quickly hit a gold miner's revenues and profit margins. You can't sidestep all of these issues, but you can minimize the effect they have on the precious metals stock you choose to buy. And the best way to do that is to invest in a streaming and royalty company like Royal Gold or Wheaton Precious Metals.
Streaming and royalty companies give cash up front to miners for the right to buy gold, silver, and other metals in the future at reduced rates. The miners use the cash to invest in their businesses (building mines, for example) or strengthen their balance sheets. Meanwhile, the streamers lock in low prices for years to come.
For example, in June 2021, Royal Gold paid $100 million (with an additional $10 million commitment) for gold produced from the NX Gold Mine in Brazil. It will pay 20% of the gold's spot price up to certain target production levels and then 40% thereafter. It doesn't matter what gold is trading hands at, Royal Gold has locked-in wide margins and it bypasses many of the risks inherent to the mining process.
Some particulars to consider
The interesting thing is that this deal is just one of more than 190 investments that Royal Gold has made. Of that total, 44 are producing properties, 16 are in development, and the rest are in the evaluation and exploration stages. Roughly 74% of its revenues come from gold, with the rest split across silver, copper, and other metals. Its mine portfolio is spread across 12 countries.
While seven of its mine investments account for the bulk of its production, the more than 100 other investments offer long-term growth opportunities -- and, for smaller-producing assets, an offset if something should go wrong at one of the larger mines.
Indeed, that's an important point to highlight. Having a diversified portfolio of mine investments helps reduce mining risk, but it doesn't eliminate it. If a mine stops producing for some reason (an accident or work stoppage, for example), the streaming and royalty revenues stop, too. The difference is that Royal Gold has more mine investments than a pure-play miner is likely to have, so the overall effect won't be as material.
Notably, Royal Gold has managed to increase its dividend annually for 20 years despite operating in the highly volatile precious metals space. Although the dividend yield is a somewhat miserly 1.4% today, if you are looking for a gold name to add to your dividend portfolio for the long haul, this is a good option to consider.
WPM Operating Margin (TTM) data by YCharts
Wheaton Precious Metals takes a similar, but slightly different, approach. For starters, its portfolio is spread more evenly across gold and silver, with gold making up around 60% of revenues and silver 36% (other metals account for the rest). So silver plays a more important role here than it does at Royal Gold. In addition, Wheaton has 24 operating mine investments and only nine development projects in its portfolio. Basically, it takes a more concentrated approach with its portfolio, focusing on larger deals with active mines. It has mine investments in seven countries.
However, the biggest difference for most investors will likely surround Wheaton's dividend, which is based on the company's performance. Essentially, it looks to pay out 30% of the average cash flow generated by its business over the past year. However, that, by design, means that the dividend will go up and down over time. The current yield is 1.5%, but that's clearly not a great indication of what investors can expect over the long term. The positive of this dividend approach is that when Wheaton does well, so will investors.
The negative is that the dividend will fall when Wheaton's business is facing headwinds. However, that may be a good option for some dividend investors, given that precious metals are often seen as safe haven investments, performing well when other parts of a portfolio may not be. In other words, right when you could use an extra boost, Wheaton may be there with a dividend increase.
Just keeps chugging along
In the end, what's most interesting about the business models of Royal Gold and Wheaton Precious Metals is that there's no reason to believe that anything is going to change. Miners will still face big business swings because of the complexity of building and running a mine and the inherent volatility of precious metals prices. This pair of streaming and royalty names, however, should keep sailing along thanks to diversified portfolios and locked-in low gold and silver prices. That's an unstoppable combination if ever there was one, and it makes Royal Gold and Wheaton two very precious options in the gold space.
