Royalty & Streaming Companies: An Excellent Way of Investing in Gold
“We are what we repeatedly do. Excellence, then, is not an act, but a habit.“
Aristotle
Key Takeaways
- The precious metals royalty & streaming companies represent an attractive way of investing in gold, as their business model offers some advantages of classical mining companies while eliminating the majority of disadvantages.
- This segment of the mining industry has grown in market capitalization from USD 2bn to more than USD 60bn in 15 years.
- An index of the precious metals royalty & streaming companies has been able to outperform the precious metals miners, gold, and silver on a regular basis.
- There are approximately 20 precious metals-focused royalty & streaming companies of different sizes and investment strategies, which offer investors relatively rich choice.
- A consolidation of the precious metals royalty & streaming industry is underway.
We truly live in challenging times, that support the importance of gold as a safe haven asset and inflation hedge. Nowadays, a wide range of options for investing in gold, as well as other precious metals, is available to retail investors. It’s possible to buy physical metals in the form of coins, medals, or bars, or to invest in one of the financial derivatives with precious metal as the underlying asset, or to invest in a mutual fund or ETF backed by physical or “paper” gold.
The advantages and disadvantages of physical metal and financial derivative investing are combined in the stocks of mining companies. These stocks are backed by real physical assets but at the same time provide leverage to the metal’s price. In other words, they are less risky than financial derivatives but riskier than physical metals. Some investors have already recognized that there is, however, one specific segment of the mining industry which offers attractive returns at significantly reduced risk: the royalty and streaming (R&S) segment.
The Royalty & Streaming Business Model
Royalty & streaming companies (R&S) do not build mines; they do not produce gold, or silver, or anything else. They do not have to deal with cost overruns, growing labor costs, or endless permitting processes. As their name indicates, R&S companies simply invest in royalties and streams. It is, of course, somewhat more complicated than it sounds.
It is important to understand what exactly a royalty or a stream is. A royalty is a right that entitles its owner to receive a share of the proceeds from the sale of a mine’s production. A stream entitles its owner to buy a portion of a mine’s production at a predetermined price, usually far below the prevailing market price. There are, however, further differences between these two asset types.
First of all, it is important to understand the difference in the purpose for which these instruments are created. Royalties are usually created in the earlier development phases of a mining project and form part of the transaction when title rights are transferred from one party to another. For example, an independent explorer sells his claims to a junior mining company for USD 1mn and a 2% NSR royalty. Streams are distinct from royalties in that they are usually created in the later development stages of a mine and form part of the mine’s financing package.
Take for example: A company needs to fund construction CAPEX of USD 500mn. It takes on USD 300mn of debt, issues new shares worth USD 100mn, and sells a 15% gold stream for USD 100mn. This way, the miner technically gives away a part of the future cash flow generated by the project, but that is a preferred option to equity financing, whereby they give away part of the company. To simplify, royalties are created when a junior explorer needs money to continue exploring his land package. Streams are created when a mine developer needs to raise capital to build a mine.
The owner of a royalty does not have to make any ongoing payments related to the royalty. He pays to acquire the royalty and then he collects payment on a regular basis. On the other hand, the owner of a stream must make not only an initial investment to acquire the stream but also ongoing payments in order to acquire his share of the mine’s production. It is important to note that the ongoing payments are usually far below the actual market price of the underlying commodity. This price can be fixed, e.g. USD 300/toz gold, or be a percentage of the prevailing market price, e.g. 25% of the average gold price recorded over the previous 30 days. As additional security for the stream owner, if the ongoing payments have been agreed at a fixed price, the contract usually includes a security clause specifying that the stream owner pays either the predetermined price or the prevailing market price, whichever is lower.
Another distinction between royalties and streams is size. While royalties usually apply to a very small portion of production, generally only up to 3% of all extracted minerals, streams routinely apply to 10-30% of a mine’s production. When a stream applies to a byproduct of the mine, the number often goes up to 100%. However, there are cases where royalties are much higher than 3%. This may cause some problems as it inflates production costs and may discourage miners from investing in further exploration and mine development.
Another consideration is the time factor. While royalties are usually applicable for the entire lifetime of the mine, streams often apply only until a prespecified volume of production is delivered. After this threshold is reached, the stream ceases to exist or is modified. For example, after 100,000 toz of gold is delivered, a stream is reduced from 30% to 15% of gold production and the ongoing payment increases from 20% to 35% of the prevailing gold price.
There are several basic types of royalties. The most common is the net smelter return (NSR) royalty. It entitles its holder to receive a certain share of gross revenues generated by the mine, minus transportation, smelter, and refining costs. Less common is the gross return (GR) royalty that is calculated as a percentage of gross revenue from the sale of mine production, with no additional costs deducted. A net profit interest (NPI) royalty entitles its holder to receive a share of profits generated by the mining asset. Its owner usually starts receiving payments only after the mine operator recovers his development costs. This type of royalty may be quite complex, and the cash flows may be hard to predict due to the accounting practices of the mine operator. There are also production royalties that are based on a fixed price per unit of production, e.g. USD 10/tonne of processed ore. Although these types of royalties are typically for iron ore mines, they do exist for gold mines, too.
Advantages and Disadvantages of the Business Model
The R&S model is unique, as it exploits some of the positive features of a classical mining company, like exposure to potential exploration success and rising metal prices, while it eliminates some risks, especially the risk of cost overruns during the mine construction phase and growing production costs. It is possible to summarize the advantages of the business model in several points:
- R&S companies face only a limited risk of growing production costs: As there are no ongoing payments related to royalties and predetermined ongoing payments related to the streams, the R&S company does not have to be concerned about growing production costs at the mine. Its cash flows will remain unaffected. However, this applies only as long as the mine remains in production. If the production costs increase to such an extent that the mine operator decides to halt mining operations, the R&S company will be negatively impacted as well. No production means no income from the stream or royalty.
- The risk of cost overruns is limited: If the mine construction becomes more expensive than anticipated, the mine operator must find additional sources of financing. This could create an opportunity for the R&S company to acquire an additional stream or royalty on the project. Even if the CAPEX grows to such an extent that the mine developer goes bankrupt, if the project is viable, another mine developer will emerge to complete the project. Although such delays may be uncomfortable, real trouble only starts for the R&S company when there is no one willing to complete mine construction.
- R&S companies are “happy campers”:[1] If the mine operator decides to expand the mine, the R&S company is not obliged to contribute any funds; however, it will reap the benefits from the expanded mining operation in the form of higher cash flows. Similarly, the R&S company doesn’t have to contribute to exploration expenses incurred by the mining company; but if the exploration program is successful and the mine’s reserves increase, the R&S company will share in the benefits. The same can be said if a completely new orebody is discovered on the property.
- Diversification is a tool for reducing risk: It is important to remember that the vast majority of exploration projects turn out to be unsuccessful. Even if an economically attractive deposit is discovered, it does not mean that building the mine is a certainty. There are numerous technical and administrative hurdles that need to be overcome first. R&S companies, especially the big ones, hold streams and royalties on tens or hundreds of properties. This helps to diversify their risk significantly.
- The R&S companies can be very cost-efficient: While a traditional mining company has hundreds or even thousands of employees, a R&S company typically employs far fewer people. For example, the world’s biggest R&S company, Franco-Nevada, had only 40 employees as of the end of 2021, while its revenue was nearly USD 1.3bn. This amounts to USD 32.4mn per employee. For comparison, the world’s biggest gold miner, Newmont Corporation, had 14,400 employees and revenues of USD 12.2bn, or roughly USD 850,000 per employee. As can be seen in the chart below, R&S companies generate significantly higher revenues per employee than traditional gold miners.
Revenue per Employee, in USD mn, FY2021
Source: Own processing, Macrotrends, Seeking Alpha, Incrementum AG
- And last but not least, R&S companies maintain leverage to growing metal prices.
However, the business model also has some disadvantages. The leverage to the metals prices is lower than in the case of the classical mining companies. And the diversification, while decreasing the risk, at the same time limits the upside potential, as the R&S companies cannot bet everything on one card, even if the card is a highly profitable multigenerational world-class project in the making.
Another disadvantage is lack of control. While the mining company can decide what to mine and when to start mine development, when to expand the mine and when to shut it down, the R&S company can only sit and wait, as it has only limited tools, if any, to affect decision making.
The lack of control may be problematic, especially when the stream or royalty is high, which may demotivate the mine operator. It limits the profitability of the mine, and the operator may start to neglect investments in further development, especially if he has other, more profitable projects. For example, Maverix Metals owned a 7.5% NSR on Karora Resources’ Beta Hunt mine gold production. This was an unusually high royalty that was created back in times when Beta Hunt was a nickel mine with some gold byproducts. Therefore, the high royalty on gold didn’t bother the old mine operator too much. However, Beta Hunt later evolved into a gold mine; and due to the high royalty, Karora was hesitant to invest in production growth. As a result, Karora and Maverix renegotiated the royalty and agreed to reduce it to 4.75%. Over the following year, Karora prepared a multiyear growth plan to increase the annual production volumes significantly.
But in general, under normal circumstances, the advantages of the R&S business model outweigh the disadvantages. Therefore, the R&S companies tend to outperform the classical miners, and their popularity keeps on growing, as evidenced by the growing number of companies in this mining industry segment.
History and the Present
The pioneer of the precious metals R&S industry is Franco-Nevada. However, not today’s Franco-Nevada but its predecessor, established back in 1983. The old company created the royalty business in 1985 when it acquired its Goldstrike mine royalty. As time has shown, this transaction gave birth to a completely new industry. Of course, the guys from Franco-Nevada did not invent royalties themselves. The royalty business model had been widely used in the oil & gas industry. But Franco-Nevada was the first company that applied it to the gold mining industry. By the way, Franco-Nevada’s Goldstrike royalty was a massive success. The mine is still in production; Franco-Nevada still owns the royalty and collects around USD 20mn per year.
Further royalties followed, and Franco-Nevada was the leader of the precious metals R&S industry when it was acquired by Newmont in 2002. But in 2007, Newmont decided to sell a big royalty portfolio that included many of the assets formerly owned by the original Franco-Nevada. Franco-Nevada’s old management, including Pierre Lassonde, its founder, decided to hit the jackpot once again. They established a new Franco-Nevada and acquired the royalty portfolio offered by Newmont. The new company followed up on the success of the old one, and now, almost 15 years later, Franco-Nevada is the biggest player in the R&S industry, with a market capitalization of more than USD 24bn, roughly equaling the GDP of Iceland. When asked about the success of Franco-Nevada and its business model, Pierre Lassonde responded:
“We get a free perpetual option on the discoveries made on the land by the operators, and we get a free perpetual option on the price of gold. It’s the optionality value of the land, the value of the operator spending money on our land, and the optionality to higher gold prices. And that is worth so much money. When you buy a stream, on the other hand, you get price optionality. You’re buying, say, 100,000 ounces of gold for the next 25 years. So you get optionality on the price of the commodity, but you don’t get much optionality on the land.”
Wheaton Precious Metals, the second biggest company in the precious metals R&S industry with a market capitalization of around USD 20bn, was established in 2004, as Silver Wheaton. As the name indicates, its primary focus was silver, which has changed over time. The first asset was a 100% silver stream from Wheaton River Minerals’ Mexican Luismin mining operations. This mine was producing approximately 8mn toz silver per year, which meant a strong start for Silver Wheaton. Further streams followed soon after. In 2004, Silver Wheaton acquired a 100% silver stream from Lundin Mining’s Zinkgruvan mine, which was supposed to deliver around 2mn toz silver per year. The company kept on growing, but it didn’t focus purely on silver, and the share of gold in its revenues kept on growing. In 2016, after the acquisition of the gold stream from Vale’s Salobo mine, the revenues became almost equally split between gold and silver. Subsequently, in 2017, Silver Wheaton changed its name to Wheaton Precious Metals. Today, the company maintains bigger exposure to silver than its peers; however, its main source of revenue is gold. In 2021, Wheaton’s attributable production equaled 342,546 toz gold, 26mn toz silver, and 20,908 toz palladium.
The third biggest company, Royal Gold, was established in 1986, when oil & gas company Royal Resources acquired Denver Mining Finance Corporation. The merged company wanted to become a gold mining company; however, it quickly refocused on the royalty business model. Its cornerstone asset became the Cortez mining complex royalty. Although restructured, it is still held by Royal Gold today.
Market Capitalization of the Precious Metals R&S Industry, in USD bn, 2004-2020
Source: Own processing, Bloomberg, Company Reports, Scotiabank, Incrementum AG
Over time, numerous new precious metals-focused R&S companies emerged. And the overall market capitalization of the industry grew as well, from USD 2bn in 2004 to USD 66bn as of April 2022.
Today, there are approximately 20 R&S companies primarily focused on precious metals. However, only 6 of them have a market capitalization of over USD 1bn: Franco-Nevada, Wheaton Precious Metals, Royal Gold, Osisko Gold Royalties, Triple Flag Precious Metals, and Sandstorm Gold. The rest are well below the USD 1bn mark. And the smallest ones, Star Royalties and Empress Royalty, each have a market capitalization of well under USD 50mn.
Market Capitalization as of April 30, 2022, in USD mn
Source: Own processing, money.tmx.com, Incrementum AG
M&A Wave Ahead?
As the number of precious metals R&S companies increased notably in recent years, the question of the inevitability of an industry-wide consolidation emerged. Investors didn’t have to wait for long. On June 21, 2021, Gold Royalty, one of the smaller players, established only in 2020, announced the acquisition of ELY Gold Royalties. And in September it also acquired Abitibi Royalties and Golden Valley Mines. Due to the acquisitions, Gold Royalty’s market capitalization increased from approximately USD 200mn to nearly USD 700mn, and its number of assets grew to more than 190. But Gold Royalty remained hungry. In December, it decided to make another acquisition. This time, it elected Elemental Royalties. However, while the first two transactions were friendly, this attempt was hostile and so far unsuccessful. On the other hand, recently announced Sandstorm Gold’s friendly acquisition of Nomad Royalty will most probably come through. It should help Sandstorm significantly boost its near-term growth prospects. Given the number of smaller players, it is possible to expect that the consolidation will continue and further deals will emerge sooner or later.
The growing number of R&S companies means that various investment strategies have also emerged. The big players have a large number of royalties in their portfolios; however, their main assets are streams. A typical stream provides a bigger cash flow than a typical royalty, which is more suitable for big companies. A royalty that generates USD 2-3mn per year may be very interesting for the smaller players like Empress Royalty or Star Royalties, but not so much for Franco-Nevada or Wheaton Precious Metals. Another advantage for the bigger players is that the streaming segment is not so crowded. There are only a limited number of companies that can afford to acquire a substantial stream valued at several hundred million USD, therefore there is lower competition. On the other hand, almost every one of the abovementioned 20 companies can afford to acquire a royalty valued at USD 20mn or less. The desire to start making bigger deals is probably one of the reasons why Gold Royalty pursues the growth path so aggressively.
Some of the smaller companies have developed specific strategies when it comes to acquiring new assets. For example, Empress Royalty stresses that it prefers creating new royalties to acquiring the old ones. Therefore, it collaborates directly with the mining companies. Vox Royalty elected to take quite the opposite route. Its main competitive advantage is a proprietary database of more than 8,000 royalties. Vox claims that it is the largest database of this kind in the world, and that it enables it to better identify and approach potential sellers of these royalties. That may be true, as shown by Vox’s recent acquisition of a royalty on Sibanye’s Limpopo project, with measured, indicated, and inferred resources of 36mn troy ounces of platinum, palladium, rhodium, and gold. Royalties and streams on such attractive assets are usually held by the bigger players. Moreover, Vox acquired the royalty at a very reasonable price.
There are also companies that create their own royalties. They technically combine the project generator and R&S business models. They originally started as project generators, but as the projects started maturing, their portfolio of royalties kept on expanding and became the more important part of their business. A typical example is our dear premium partner EMX Royalty, formerly known as Eurasian Minerals. Today, EMX owns nearly 150 royalties on projects in different parts of the world, but it also has numerous exploration projects and keeps on selling them to other companies.
And then there are companies that adopted, or tried to adopt, a hybrid model. That means they not only invest in streams and royalties but also try to develop their own mining projects. Although this model may provide attractive upside potential, it also brings back some of the operational risks that the typical R&S business model eliminates. This is why the hybrid model is not too popular among investors. A good example of the challenge is Osisko Gold Royalties. In late 2019, after the acquisition of Barkerville Gold and its Cariboo project was announced, Osisko’s shares started lagging behind its peers. The situation began improving in the autumn of 2020 when a spin-out of the exploration project into a separate entity called Osisko Development was announced and completed.
Attention should also be paid to the newest trend in the R&S industry, carbon credit streaming. The recent surge in carbon credit prices attracted the R&S companies. For example, Star Royalties established a daughter company called Green Star Royalties that is investing in carbon offset projects. The carbon streams and royalties work in the same way as the gold streams and royalties. The difference is that the cash flow is not generated by a mining project but by a carbon offset project. The carbon offset projects, e.g. forest planting, reduce the volume of carbon dioxide in the atmosphere. The project operator receives carbon credits equivalent to the volume of eliminated carbon dioxide. The carbon credits are subsequently sold to companies, e.g. steel makers, coal plants, etc., that need them to compensate for the carbon dioxide they release into the atmosphere. Star Royalties is just a a small player entering the carbon streaming industry. The leader of this R&S industry segment right now is Carbon Streaming Corp. Further IPOs are expected in this segment.
The performance of the R&S industry
As mentioned earlier, the R&S companies have numerous advantages in comparison to the common mining companies. This makes them an attractive investment option. However, what is probably the most important is their performance in comparison to other assets, whether the mining stocks or physical metals.
The chart below shows the performance of a simple R&S index calculated as an average return of the top 5 industry players – Franco-Nevada, Wheaton Precious Metals, Royal Gold, Sandstorm Gold, and Osisko Gold Royalties (added as of July 7, 2016). As can be seen, over the last 10 years, the R&S index outperformed gold, represented by the SPDR Gold Trust ETF (GLD), and silver, represented by the iShares Silver Trust ETF (SLV), as well as gold and silver miners, represented by the VanEck Vectors Gold Miners ETF (GDX) and VanEck Vectors Junior Gold Miners ETF (GDXJ). The outperformance of the precious metals miners is especially impressive: When the R&S index grew by 90%, the GDX declined by 41% and the GDXJ by 64%.
Performance of GLD, SLV, GDX, GDXJ, and R&S, 0% = 12/2011, in %, 12/2011-04/2022
Source: Own processing, YahooFinance, Incrementum AG
The R&S companies have recorded superior performance on shorter time periods, as shown in the chart below. They outperformed GLD, SLV, GDX, and GDXJ over the 5-year, 3-year, and also 1-year time periods. The only exception is GDX over the last 3 year, as it grew by 67,5%, while the R&S index grew by 67.46%.
Performance Comparison, in %, 04/2017-04/2022
Source: Own processing, YahooFinance, Incrementum AG
Conclusion
R&S companies are an important segment of the mining industry. There are approximately 20 precious metals-focused R&S companies of different sizes and with different business strategies, which offers investors diverse options. In general, the precious metals R&S companies offer an attractive way to invest in precious metals. They offer exposure to growing metals prices, while eliminating operational risks related to classical mining companies. Moreover, as the historical data shows, this mining industry segment is able to outperform gold and silver, as well as gold and silver miners, on a regular basis.
There is space for further growth of the R&S industry. Moreover, investors may also benefit from adopting some new trends, such as carbon-offset streams, or from taking advantage of the consolidation that is ongoing in the industry right now.
[1] They can just sit and wait for the others to do the work, and then reap the benefits.
