Gold miners come in lots of different shapes and sizes. But by universal agreement the best business model in that space is the royalty/streaming company, which works as follows:
Say you’re running a small exploration company and you’ve found a promising gold deposit. If mined successfully it’s probably worth a lot of money. But building a mine costs millions of dollars and traditional banks won’t fund such a risky venture. What do you do?
One possibility is to show your discovery to a “royalty” or “streaming” company which, if it likes what it sees, will offer to finance all or part of the mine, in return for which you agree to pay your benefactor some portion of the gold you produce (a royalty) or sell it part of your future production for a very low price (stream). You get your mine and most of the wealth it produces, while the royalty/streaming company gets a predictable inflow of gold without the complexity or risk of actually running a mine. (This works for silver too. I’m focusing on gold for narrative simplicity.)
The biggest royalty/streaming companies have dozens of deals producing steady cash flows which, thanks to being diversified across many mines in different locations, carry vastly lower risk than a single mine.
Here, for instance, is what happens to a small miner if one of its handful of mines doesn’t work out.
An established royalty/streaming company, in contrast, isn’t existentially threatened by trouble at any one mine. But it retains the operating leverage of a miner, with profit margins that can explode if the price of gold rises.
This presents a lazy gold stock investor with a very easy strategy: just buy a bunch of high-quality royalty/streaming companies, and that’s it. No need to research mine operating results or stress over political risk or environmental issues in exotic places. Just create your portfolio and spend the next decade on the beach or the golf course, safe in the knowledge that when (not if) gold finally soars, your gold stocks will soar even more.
This strategy has literally only one, easily managed, drawback: Because the advantages of this business model are so obvious and well-understood, the royalty/streaming companies tend to be valued more richly than other equities in this space, which makes timing crucial. You don’t want to load up on these shares after they’ve already had a nice run because that limits your upside and increases the risk of a quick 50% paper loss.
Luckily, most of these stocks are volatile, which means they frequently present nice entry points. An example is Royal Gold, which will do just fine in the long run but tends to bounce around in the moment. Today it’s trading at 126 but in the past few years it could have been bought below 90 multiple times. So use good-until-canceled low-ball buy orders, or sell puts (more about this strategy in a later post), or just wait until your targets correct. Or dollar cost average by buying a fixed dollar amount of these shares each month.
For a deeper dive into the royalty/streamer story, here’s a video in which mining analyst Rick Rule calls them his favorite kind of mining stock, “when the price is right.”
The following table lists some well-regarded royalty/streamer companies. A portfolio of these stocks – bought after corrections – will, says Rick Rule, generate most of the gains of actual gold and silver mining stocks, with a fraction of the drama.
I’m not an expert at all in PM mining stocks, nor royalty and streaming companies, but the more I think about them from an investor’s perspective the more circular it all becomes.
First of all, the basic premise of all discussions about PM investing is that it’s hard to identify companies that will be successful, or more crucially, profitable to stock holders. One of the arguments for royalty or streaming companies is that - presumably - they are better judges of resource businesses, better than most retail investors. That may or not be true, but even if it is the retail investor needs to choose which R or S companies to invest in, and that means one needs to know about the businesses they are invested in, and their managements, which takes you back to square one.
Therefore, finding a good R or S company is basically no different than finding a good resource producing company and investing in it directly. Now, one may counter that with the fact that R and S companies afford diversification so one is not wholly invested in any one company, but there are other ways to gain the same if not greater diversification.
For example, the ETF GDX is invested in about 53 PM companies - some of which are royalty and streaming companies, and about 64% of the fund is invested in ten of the “biggest” ones, including many of the ones Rick Rule and JR cited, such as Franco-Nevada (8.8%), Wheaton (5.9%), Royal Gold (3.2%) and Sandstorm (.68%). My point is that by investing in something as simple as GDX one gets instant diversification across many companies, including exposure to R and S companies. Furthermore, according to Rick Franco-Nevada Corp is the best of breed and one could do well investing it that one alone. However, the charts of Franco-Nevada and GDX are almost identical and GDX provides the added diversification of both R and S companies and mining stocks. I don’t know why they are so similar because Franco is only 8.8% of GDX but it either shows what I’m trying to say or perhaps the R andS companies haven’t really distinguished themselves yet because the gold/silver prices have increased enough.
Now, one could argue that R and S companies are “better” than actual mining companies because they aren’t as exposed to all the costs of the miners, but that doesn’t mean the R/S company’s investments in the miners are cost free. If the miners don’t perform then the R/S companies don’t get a return on their investment, which by extension means returns to the investors in the R/S companies themselves are not so great. There are no guaranteed minimums, for example.
Another thread: Whenever there is “universal agreement the best business model in that space is…” you can be pretty sure that it’s overcrowded and overbought. Again, basically R/S companies are “stock pickers” themselves in that whatever companies they have agreements with are still subject to whatever issues those companies may face, such as taxations, land use restrictions, “clean energy” costs, etc. Those may not require additional costs to deal with them but their returns are bound to be affected negatively as well.
Furthermore, extremely few professional investors (e.g., “fund managers") are able to beat the baseline average performance over the long run. There can be a lot of “churning” and volatility but in the end very few can exceed the average return. That’s not to say that some individual stocks don’t do extremely well it’s that the odds of having a disproportionate number of them in a portfolio is very low. This was the entire basis of “unmanaged” vs “managed” mutual funds, as pioneered by Vanguard investment company. Over the long run managed funds tend to do no better than unmanaged ones, and when expenses are deducted they lag by several percentage points.
Personally, Most of my PM stock allocations are 50-50 GDX and GDXJ (the junior miners), with some in a silver ETF to (hopefully) spice things up, and also small equal amounts in a about 10 different “penny stock” gold and silver miners. I can’t say it’s been great but I‘ve known all along that those things are fickle and speculative, but it’s fun to see the gold and silver roller coaster. Fortunately I haven’t lost anything and I still think it’s going to be the place to be when sentiment finally changes. And that is true of R and S companies just as much as mining stocks.
Sandstorm (SAND) and Osisko (OR) have a lot of growth baked in and are cheaper than some of the others.