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Even as the price of gold has shown considerable upward volatility this year, gold royalties have escaped much of the consideration that has been offered for exposure through gold equities, gold bullion, or gold exchange traded funds.
Even as the price of gold has shown considerable upward volatility this year, gold royalties have escaped much of the consideration that has been offered for exposure through gold equities, gold bullion, or gold exchange traded funds. Gold royalties function primarily by: either owning the mineral rights to land and allowing other gold miners to drill for a share of whatever is obtained or, by providing capital to finance miners for rights to gold. Gold royalty companies can provide exposure to gold price appreciation to portfolios with the enhanced benefit of lower risks to increased operating and labor expenses as well as mitigated liability and environmental exposure. A typical gold royalty company business model benefits from rising gold prices and new discoveries while limiting operating and capital cost inflation.
Challenges exist
It might seem that a principal challenge for gold royalties is to negotiate agreements and partnerships with operations demonstrating sustainable gold streams as byproduct over the long term.
Structured investments are sometimes centered on a concept referred to as volumetric production payments (VPPs). A net profit interest (NPI) royalty is a royalty structure which provides the royalty owner with the net profit, after deducting the defined costs related to the production for the mine. Additional agreements may provide net smelter returns (NSR) which is a royalty structure whereby the owner of the royalty obtains a percentage royalty of net production value generated by the operator at the smelter-level.
The companies they deal with are often primary producers of other metals and commodities such as uranium, copper, nickel, zinc, or oil and gas. Gold may only represent a relatively minor share of their segmented revenue stream in the range of 5 to 20 percent indicating that underlying operation has to continue to operate and be sustainable at low metal prices for their primary metals.
A royalty company must rely on rational allocation of capital and excellent due diligence in order to avoid entering into a contact with a mining operation that would have to shut down because of low metal prices.
Focused leverage
In an interview on Business Network News (BNN) the benefit of leverage was disclosed by David Harquail, President and Chief Executive Officer of Franco-Nevada Corporation (TSX:FNV), “as the gold price goes up we get the benefit of the higher gold price, but what is also happening is the operators of our assets are expanding operations. They are adding new reserves. They are increasing their throughput, putting more capital in their projects and we benefit from that. So [return on investment] is 50 percent acquisitions, 25 percent price and 25 percent organic.” The CEO discussed future strategy and exposure to oil and gas projects after a very busy week for Franco-Nevada following a recent listing on the New York Stock Exchange on September 6 and a ceremonial initial bell ringing to signify the morning opening of the exchange on September 8.
Investment Opportunities
Royal Gold (NASDAQ:RGLD), Sandstorm Gold (TSXV:SSL), and Franco-Nevada have all experienced share price appreciation with respective returns of 51.2, 77.5 and 39.8 percent on a year to date basis. This compares favourably to the rate of return of 8.7 percent for an average gold equity, represented by the Market Vectors Gold Miners ETF (NYSE:GDX), which consists of a broad portfolio of small, mid-sized and large gold mining equities from around the globe. The gold royalties have even outperformed the impressive performance of the gold spot market prices with a return of 31.2 percent on a year to date basis.
Spot market prices
Spot market gold prices declined slightly with market attention keenly awaiting a speech expected in the evening by President Barack Obama. The primary catalyst for the decline was the failure to deliver firm promises of further monetary easing during a well anticipated speech by Federal Reserve Chairman Ben Bernanke. Gold prices increased during the regular trading session as traders and investors became wary of holding risky assets like equities and commodities ahead of speeches by Bernanke and Obama. The current spot market price for gold is trading in the range of $1871.70.
Securities Disclosure: I, Dave Brown, hold no direct investment interest in any company mentioned in this article.
