Over the past five years, precious metal royalty and streaming bigwig Royal Gold (NASDAQ:RGLD) has soared around 90%.
Royal Gold's gain over the past five years is by all measures a mouth-watering return for growth investors, especially when stacked against the returns that gold mining companies have given over the same period of time. To put this assertion into greater context, Barrick Gold Corporation (NYSE:GOLD), a major gold miner, has by contrast declined around 42% over the same period.
What is driving the growth?
Investors are increasingly interested in companies that acquire and manage precious metals royalties and streams. This is because of the unique exposure to gold that these companies present relative to mining companies' or the precious metal itself, which pays no dividend.
Royal Gold acquires royalties -- which in the context of mining are the rights to receive a percentage of mineral output from a mining operation -- directly from existing companies or gets new royalties from up-starts in exchange for exploration capital. It also provides capital to operators or explorers in exchange for metal streams. Streams give it the right to purchase all or a portion of output produced at the base mine at a predetermined price that is typically lower than the prevailing market prices.
The Royal Gold business model is becoming increasingly attractive as it gives investors incomparable certainty. This is because companies such as Royal Gold are not exposed to the vagaries of mining costs and are instead financiers with a fixed cost of doing business. Moreover, they sell the gold they get through royalties and streams as and when they see fit, allowing them to not only sell at a premium relative to the fixed acquisition price earlier agreed upon with the miners, but to time the gold market at its peak.
This model has allowed Silver Wheaton Corp (NYSE:SLW), which predominantly finances silver miners, to grow around 250% over the past five years, signaling investors' increased appetite for streaming companies.
More upside ahead
The biggest misconception among investors is that if a trend gets overwhelming coverage in mainstream media, then it's probably too late to ride the gravy train. Despite the gains that streaming companies have made in the past half decade, significant upside still remains ahead.
"What we've seen in the last six months is that people are knocking on our door," said Randy Smallwood, Silver Wheaton chief executive and president, on the sidelines of the Prospectors and Developers Association of Canada conference in March, 2014, as cited on The Globe and Mail. "It's the same people that we've talked to in the past, but they are either opening the door for the first time or they are actually coming and knocking on our door and saying, 'You know that proposal you had for us a few years ago? We wouldn't mind refreshing it and seeing what you've got," he was further quoted to say.
This statement from Smallwood says it all—miners are desperate for capital. Apparently, the equity market is not as forthcoming for miners and other credit financiers such as banks and bond investors are looking away from mining stocks. This is not a situation exclusively isolated to silver miners, as may be misconstrued by the context of Smallwood's remarks. Gold miners, too, who regularly turn to Royal Gold for capital in exchange for royalties and streams, are desperate.
Gold miners have come under a lot of pressure in recent years over increased mining costs, and a gloomy long-term price outlook for gold, induced by speculation that the Fed may increase interest rates based on increasingly positive job data. The increased costs, however, seem to be the biggest setback as prices often recover on other factors such as geopolitical drivers and jewelry demand.
The cost of building a mine has increased markedly over the past 10 years from $560 per ounce of gold production capacity in 2004 to more than $2,300/oz in 2013, according to SNL Metals & Mining, a leading provider of global mining information and analysis.
Increased costs mean that miners are desperate for more capital to sustain production levels. Worse still, the equity and credit investors have turned away from miners. A case in point is Barrick Gold, which coincidentally also sources financing from Royal Gold. Potential partners have shown disinterest in financing Barrick Gold's giant Pascua-Lama project on the border of Chile and Argentina, where operations were shelved following wrangles with locals over the mine's environmental impacts.
The current high demand for capital by gold miners, and the corresponding reluctance by equity and credit investors to provide financing, means that streaming companies can negotiate for more royalties and more streams from miners.
Going forward, Royal Gold, which grew its cash flows by $261.3 million in 2012 and $288.5 in 2013, can leverage its strong cash position and easier access to capital to finance miners' operations at premiums—in other words, negotiate for more royalties and streams in the future than it would today using the same amount of capital. There is still time for growth investors to get on this gravy train.