Investing in gold and silver mining stocks is not for the faint-hearted, and it has been especially unprofitable during the last few years with the collapse in the share price of precious metals prices. With the bloodbath come potential opportunities, however, and investors looking to bet on a rebound in precious metals prices can significantly reduce their investment risk by focusing on precious metals royalty companies.
I believe investing in diversified precious metals royalty companies such as Silver Wheaton Corp. (USA) (NYSE:SLW), Royal Gold, Inc USA) (NASDAQ:RGLD), and Sandstorm Gold Ltd. (NYSEMKT:SAND) can allow investors to participate in a rebound in gold and silver prices while skirting much of the operational risks that a mining company would be exposed to. Investing in well-run royalty companies should also allow investors to benefit from production growth and dividends, providing an additional advantage over holding the precious metals directly in physical or ETF form.
How a royalty structure reduces risk
For those unfamiliar with how a mining royalty company operates, these firms help finance the construction of a new mine and in return receives a “stream,” i.e. a percentage of the future metals production of the financed mine. Usually, the royalty company pays a nominal, fixed cost per ounce when procuring the metals stream from the mining company, although this cost is typically much below the market price for the metals and only helps to cover some of the operating costs of the miner.
It is important to remember that royalty companies acquire the metals stream from the financed mine at a fixed nominal cost per ounce. This is because one of the main headwinds for precious metals miners in recent years has been that unit production costs have been rapidly increasing and thereby compressing profit margins. However, a metals streaming company is not affected by this cost inflation because of the terms of the financing agreement. As a result, precious metals royalty companies gain pure exposure to gold and silver market prices, without having to worry about production costs.
Although metals royalty companies aren’t exposed to cost fluctuation, they can be hurt by production shortfalls at the mines they have financed. For example, if a financed gold mine doesn’t produce as many ounces as expected, then the gold stream attributable to the financing royalty company would correspondingly shrink. On the flip side, however, if a financed gold mine produces more ounces than expected, then the gold stream received by the royalty firm may actually increase. Therefore, this exposure to mine production can offer both risk and reward, and should not be viewed as a negative factor.
Investing in precious metals streaming companies rather than in gold and silver directly differs because of this aforementioned exposure to mine production variance. An investment in royalty companies offer pure exposure to the precious metals prices without being affected by production costs, much like a direct investment in the metals.
However, royalty companies also offer additional upside because of the potential for the financed mine to produce more metals than projected, or to undertake brownfield expansion to extend the mine life. In addition, larger and more mature royalty companies can offer investors significant dividend yield. For example, the largest precious metals streaming company, Silver Wheaton Corp. (USA) (NYSE:SLW), offers a dividend yield well above 2%, and Royal Gold, Inc USA) (NASDAQ:RGLD)’s dividend yield is approaching 2%.
Lineup of diversified royalty companies
I will briefly touch on three of the largest precious metals royalty companies in this article: Silver Wheaton Corp. (USA) (NYSE:SLW), Royal Gold, Inc USA) (NASDAQ:RGLD), and Sandstorm Gold Ltd. (NYSEMKT:SAND).
Silver Wheaton Corp. (USA) (NYSE:SLW) is, of course, the largest and oldest precious metals royalty company in the world. Silver Wheaton Corp. (USA) (NYSE:SLW) has a well-diversified portfolio of primarily silver royalty streams from 19 operating mines.