Why Should You Consider Precious Metal Royalty Companies?

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One of the downsides to owning gold and silver in your portfolio is that these assets do not pay a dividend. For retirees, this could be a serious problem, and it may dissuade them from investing in precious metals. True, investors seeking income from precious metals could look to mining companies — but mining is a risky business. Furthermore, if we take a look at gold and silver mining companies that pay dividends, we find that several of them have cut their dividends recently due to low metal prices. Some examples include Gold Resource Corp. (AMEX:GORO), IAMGOLD Corp. (NYSE:IAG), and Barrick Gold (NYSE:ABX).

Fortunately, investors have another option — gold and silver royalty and streaming companies. Royalty and streaming companies are like banks that deal exclusively with mining companies. A royalty or streaming company will agree to pay a mining company a certain amount of cash, or sometimes stock, in exchange for the right to future metal production at a fixed cost (which can be $0), regardless of the price of the metal. Specifically, a royalty agreement is one in which the royalty company doesn’t have to pay for each ounce of metal it receives. A streaming agreement entitles the company to buy the metal at a fixed price that is usually well-below the prevailing market price.

Let us take a look at an example of a royalty deal. Royal Gold (NASDAQ:RGLD) has an agreement with Thompson Creek Metals (NYSE:TC) that gives it the right to buy 52.25 percent of the gold produced at the latter company’s Mt. Milligan mine in British Columbia for $435/ounce, regardless of the price of gold. In order to get this right, Royal Gold paid nearly $800 million to Thompson Creek, which used this capital to develop the Mt. Milligan mine. Such a deal benefits both companies. Thompson Creek gets capital that it needs in order to develop its mine, while Royal Gold gets a future cash-flow stream that is leveraged to the gold price.

A royalty or a stream is a much more compelling investment from the perspective of somebody looking for low-risk exposure to the price of gold. Royal Gold doesn’t have to worry about fluctuating production costs. Furthermore, because Royal Gold has several of these agreements in place if one or two go sour it can remain profitable.

As a result of these advantages, royalty and streaming companies have seen their businesses grow over the past several years. Their share prices have increased markedly, and they have paid rising dividends. Investors interested in royalty companies for their retirement or income portfolios should consider three companies: Royal Gold, Franco Nevada Corp. (or, FNV), and Silver Wheaton (NYSE:SLW).

Royal Gold is the smallest of these companies. It has royalty agreements on over 100 mines that give it the right to various metals, although mostly gold. We have already looked at its Mount Milligan deal, and it has several other important royalties in place that are generating a lot of cash-flow. Other notable royalties include:

  • Penasquito, operated by Goldcorp (NYSE:GG) which entitles Royal Gold to 8,000 ounces of gold per year at no cost.
  • Andacollo, operated by Teck Resources (NYSE:TCK), which entitles Royal Gold to about 45,000 ounces of gold annually at no cost.
  • Voisey’s Bay, operated by Vale (NYSE:VALE), which entitles Royal Gold to about 2.3 million pounds of copper, 3.8 million pounds of nickel, and 90,000 pounds of cobalt on an annual basis at no cost.

All of these deals are on mines that will produce well into the future, and barring a deflationary calamity, Royal Gold will generate significant profits from these deals and its other royalties for years to come. Franco Nevada Corp. is the largest royalty company with a gold focus. It has a stellar balance sheet with $841 million in cash and no debt. Franco Nevada is highly diversified, although it has one very large streaming deal on Coeur d’Alene’s (NYSE:CDE) Palmarejo mine in Mexico that accounts for nearly a quarter of its attributable gold production. Other notable deals include:

  • The right to 2 percent of the gold produced at the Detour mine in Ontario owned and operated by Detour Gold (or, DRGDF), which should generate about 15,000 ounces per year at no cost.
  • The right to 6 percent of the gold produced by Teranga Gold (or, TGCDF) at its Sabodala project in Senegal, which should generate about 15,000 to 18,000 ounces per year at no cost.
  • The right to 2 to 4 percent of the gold mined at Barrick Gold’s Goldstrike mine in Nevada, as well as the right to another 4 to 6 percent of the profits from the Gold Strike mine. The percentage received depends on the part of the very large mining project that Barrick mines the gold from.

Really, the only thing not to like about Franco Nevada is that it is a favorite among gold investors, and so the shares are somewhat expensive relative to its peers. Therefore, I think this is a great stock to buy on weakness, especially if we see another down-leg in the price of gold in the coming months.

Silver Wheaton is the largest of the three companies. It focuses on silver rather than gold, although recently it has made a couple of deals with Vale and Sandspring Resources (or, SSPXF) for gold streams. The company has a couple of very large deals, including one for the silver produced at Pensquito that entitles it to 25 percent of the silver produced here, or 7 million ounces annually, for just $3.90/ounce. Other deals include:

  • The Yauliyacu streaming deal. The Yauliyacu mine in Peru is operated by Glencore Xstrata (or, GLCNF). The deal entitles Silver Wheaton to 4.75 million ounces of silver annually at $3.90/ounce.
  • The Rosemont streaming deal. The Rosemont mine in Nevada is being developed by Augusta Resources that will be producing 2.9 million ounces of silver annually for over 20 years. Silver Wheaton is entitled to all of it at just $3.90/ounce.
  • The San Dimas streaming deal. San Dimas in Mexico is operated by Primero Mining (NYSE:PPP). The deal entitles which entitles Silver Wheaton to 6 million ounces of silver annually plus half of the silver produce beyond that amount for just $3.90/ounce.

All three companies are comfortably profitable and growing rapidly. They all pay dividends that have been rising. Ultimately, you will probably make more money if you pick the right mining companies than if you buy royalty and streaming companies because the leverage is much greater. But mining is a far riskier business and it is much more difficult to pick a good mining company than to simply buy one of the three royalty/streaming companies that all have impeccable track records of value creation. Therefore, retirees and those investors that do not have expertise in mining should focus on these companies, and I believe that they will make a lot of money doing so.