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A 'lower-risk' play on the volatile gold sector
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With lower costs than miners, precious metals royalty and streaming companies can be a more defensive bet
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By SHIRLEY WON
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Special to The Globe and Mail
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Wednesday, October 9, 2019 – Print Edition, Page B6


Gold has been glittering this year, signalling that a new bull market for the yellow precious metal could be on the horizon.

The price of gold has surged by about 18 per cent this year amid falling interest rates, trade tensions and slowing global growth.

Comex gold futures rose to a high of US$1,552 an ounce last month before pulling back recently to the low US$1,510 range.

Although gold - a safe haven during uncertain times - and mining stocks can be volatile investments, owning shares of precious metals royalty and streaming companies can be a more defensive bet. Some pay dividends, too.

These companies are a "lowerrisk" play because they have substantially lower costs than miners do, as they don't have to develop and operate mines, says Jon Case, portfolio manager at Sentry Investment Management, a division of Toronto-based CI Investments Inc.

Under their business model, royalty and streaming companies provide upfront cash - an alternative form of financing - to miners in exchange for a percentage of gold or other metals produced typically for the rest of a mine's life.

They can negotiate royalty and/or streaming agreements with miners (or even with oil and gas producers). Royalties are typically paid in cash, while streams usually involve deliveries of the metal or commodity.

As royalty and streaming companies don't operate mines, "you see margins of 70 or 80 per cent versus maybe 30 per cent for a conventional mining company," Mr. Case says.

"When you have bigger margins and the metal price drops, you are less impacted. You have more of a cushion," he adds These players can also benefit if a miner does further exploration that results in the life of a mine being extended, Mr. Case says. "They get that benefit without having to pay upfront for it."

Royalty and streaming companies can differ vastly, too. Toronto-based Franco-Nevada Corp.

(FNV-T), which provides an annual dividend of $1 a share, received 87 per cent of its revenue last year from gold and the rest from energy deals. For Vancouver-based Wheaton Precious Metals Corp. (WPM-T), which has a variable dividend, 56 per cent of its revenue came from gold and 44 per cent from silver.

These larger players also may not be as diversified as they may seem despite owning hundred of royalties and streams. It's possible to have multiple deals on the same mine, and a hiccup at one can affect their cash flow, Mr. Case says.

For example, streaming payments to Wheaton stopped temporarily this year when Denverbased Newmont Goldcorp Corp.

had to suspend operations at its Penasquito mine in Mexico due to local protesters blocking entry to its property.

And miners may have operations in Latin America and Africa, where political conditions can affect operations, he notes. "You can't just blindly buy [these stocks] and expect to own a diversified portfolio that's riskless."

Still, the conventional wisdom is that these companies are a way to invest conservatively in the space, or when metal prices are flat or trending lower, he says. Mr.

Case holds Wheaton in the Sentry fund because it's valued attractively compared with Franco-Nevada, while Sandstorm Gold Ltd.

(SSL-T) of Vancouver is also a "valuation call."

U.S. Global Go Gold and Precious Metal Miners ETF (GOAUA), which produced a return of 46 per cent for the 12 months ended Sept. 30, has a hefty 37 per cent of its assets in royalty and steaming companies. Denver-based Royal Gold Inc. (RGLD-Q), Franco-Nevada and Wheaton are the exchange-traded fund's (ETF) biggest holdings, while Sandstorm and Montreal-based Osisko Gold Royalties Ltd. (OR-T) are also among the top 10 names.

This ETF, which uses a "smart beta" approach, has a heavy weighting in these companies because they meet certain criteria better than others, says Michael Matousek, head trader at San Antonio-based U.S. Global Investors Inc. For example, these could include revenue per employee, gross margins, cash flow and return on investment capital.

Royalty and streaming companies also attract managers of the big equity mutual funds when they want exposure to this space during times of uncertainty, Mr.

Matousek says. "What they like about it is that the revenue stream is very steady - not up and down like a traditional miner. ... In the gold world, it's a safer play."

However, these companies can lag during periods of speculative fever when investors will throw money at junior gold miners whose shares "start to pop in price," he says. If the gold price falls sharply, he notes, these juniors will, too, because they don't tend to have strong financial resources behind them.

Although royalty and streaming companies may not be the top performers during these periods, Mr. Matousek says, "over time they generally work out to be a safer bet."

Rick Rule, president and chief executive at Carlsbad, Calif.based Sprott U.S. Holdings Inc., favours these precious metals players as a good way to participate in a potential gold-equity bull market rather than chasing the juniors with their high production costs and low-profit margins.

A generalist investor should first consider the big royalty and streaming players, which are "more efficient companies with much higher margins, able to withstand downturns better and, surprisingly, are able to grow," Mr.

Rule says.

He dismisses any suggestion that these companies' growth is past them because they have already picked the low-hanging fruits in terms of available deals and that miners won't need financing as their stocks rise in a rallying gold market.

That's because the Basel III accord - a set of reforms introduced in 2009 to improve regulation and risk management in the global banking sector - reduced the ability of financial institutions to provide merger and acquisition as well as project financing to non-investment-grade issuers, he says.

"The lack of availability or high cost of capital to non-investmentgrade mining companies in the next five and 10 years opens the door to literally billions of dollars of transactions for the royalty and streaming companies " Smaller royalty and streaming companies, which trade at a lower earnings multiples, can also be opportunities, Mr. Rule says.

"There is the potential that the small guys could develop a big enough inventory that they become meaningful to the big ones."

They could be takeover candidates or enjoy a "re-rating," whereby investors are willing to pay a higher price in anticipation of higher future earnings, he says.

Associated Graphic

Miners may have operations in Latin America, such as this Vale facility in Brazil, where political conditions can affect operations.

SALVIANO MACHADO


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