If you are looking at the precious metals rally and thinking you should jump aboard, you might be interested in a miner like industry giant Barrick Gold (NYSE:ABX). That's well and good, but you should take a step back before jumping aboard Barrick and look at Royal Gold (NASDAQ:RGLD), which isn't a miner, but still gives you that direct gold exposure. Here's what you need to know to figure out which one is a better buy.
The business model difference
Barrick's business model is pretty straight forward. It unearths precious metals and sells them. That's an expensive and risky process, of course, but it isn't hard to understand. Royal Gold sells gold, too, but it never touches any dirt. It's more like a specialty finance company where its key customers are gold and silver miners.
Here's how it works. A miner like Barrick Gold needs money for some reason. The reasons vary, from simply being short on cash because of a weak gold market, like we've seen recently, to finding a great new opportunity to build a mine. There are a few ways Barrick could raise the cash, including selling stock, selling bonds, taking a loan from a bank, or dealing with a streaming company. The first three can be costly, because of things like high interest rates and shareholder dilution. A streaming deal, however, can be relatively cheap.
That's because Barrick gets its money up front and pays for the cash by selling a streaming company like Royal Gold precious metals at a future date at a reduced cost. In fact, Royal Gold and Barrick inked just such a deal late last year. Royal Gold will pay 30% of the spot price for a portion of the gold and silver produced at Barrick's Pueblo Viejo mine until certain volume targets are hit, then it will pay 60% of the spot price.
This is good for Barrick because when the deal was signed its stock was in the dumps and banks and investors were leery of lending to miners. So it got a roughly $600 million cash infusion at a better rate than it otherwise could have. It's good for Royal Gold because the deal increased the company's "production" of silver and gold. Royal Gold, meanwhile, uses short time financing to pay for such deals and then issues stock to permanently finance them, so it's cost for the capital it employed was relatively low.
You say potato, I say ...
But which model is better? That answer depends on you. Royal Gold tends to have a more stable business because it's costs are locked in and low and it doesn't face as many risks or operating costs as a miner. In fact, it has been able to use the downturn to its advantage by making deals like the one it inked with Barrick. Which is why it's hitting new production records and has been able to increase its dividend for 15 consecutive years despite the commodity downturn that started in 2011.
However, that stability means there's both less downside risk and less upside potential in the shares because investors are well aware of its differentiated business model. For example, since the commodity peak in 2011, Barrick's shares are down some 60% while Royal Gold is actually up around 9%. These figures include the year-to-date precious metals rally. So you can see where a conservative investor might prefer to get their gold exposure via an investment in Royal Gold.
But if you look at the year-to-date span, the precious metals rally has been much more kind to Barrick, which is up over 150%, than to Royal Gold, which is up "just," 60% or so. Yes, over the longer period Royal Gold still wins out on stock performance, but if you are only interested in catching the precious metals uptrend, then perhaps you don't care about that. In which case, you'll get more bang for your buck with an investment in a miner like Barrick during a precious metals rally.
It's all you
In the end, neither Barrick nor Royal Gold is really better or worse. They are different ways to play the same space. What will make one better or worse for you will be how you want to invest in precious metals. If you like to sleep well at night without having to worry about often volatile commodity prices, then Royal Gold is probably the better choice. That's particularly true if your interest is in adding a long-term position to diversify your portfolio. If you think gold and silver still have room to run, however, and want to get "a piece of the action," than Barrick will probably be more to your liking. Just be sure you're ready for the downside if gold and silver fall on hard times.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.