Stocks were positive in early trading after the U.S. Labor Department reported its much-anticipated Consumer Price Index fell 0.1% in December, in line with economist expectations after increasing 0.1% in November. Market participants are hopeful that the Fed will slow the pace of its increases in borrowing costs as inflation eases off its highs.
Gold prices have ripped higher over the past two months as expectations that the Fed will slow its interest rate rises boosted the precious metal to nearly $1,900 per troy ounce, reaching the highest level since April 2022. Gold’s latest 50-day run marks its best since the pandemic shook global markets in 2020, which sent prices above $2,000 per troy ounce.
Today we’re highlighting an approach to gold investing that you may not have considered. On the spectrum of risk for precious metal investing, this approach falls somewhere between metal and miner. But when it comes to returns, companies in this category have been outperforming for quite some time.
Investing in precious metals often seems to be reduced to two options. You can either buy physical gold/silver – the more straightforward, less risky option but often with the lowest returns, or invest in specific mining companies – which requires significant research and generally carries more risk.
But there is another option that often goes overlooked– royalty companies. On the spectrum of risk for precious metal investing, royalty companies fall somewhere between metal and miner. But when it comes to returns, gold royalty companies have been outperforming for quite some time.
Over the past seven years, royalty and streaming companies have significantly outperformed in both bull and bear markets. An index of five central precious metals royalty and streaming companies significantly outperformed gold and the GDX over the past seven years with a return of 128% versus gold’s return of 47% and the GDX’s return of 51%.
So what is a royalty company? A royalty company provides funding to the mining company for the tremendously expensive task of building a mine. Once the mine is producing, the royalty company receives a percentage of that production at a predetermined price or a share of the profit after the gold is sold.
Since the prices for mining output are already set, royalty companies can still make money even when gold prices are falling. Plus, they don’t participate in the operations of the mines themselves, so royalty companies don’t have to deal with the burden of operating costs and therefore take on much lower levels of debt than producers.
Royalty companies also have the ability to pick and choose their projects and typically hold a diversified portfolio which minimizes concentration risk. If things take a turn for the worse with one project, the company usually has several more to fall back on. Plus, the dividends of royalty companies are much more consistent and less affected by precious metal price movements than mining companies.
Royalty and streaming companies’ unique business model supports miners and produces cash flow, offering investors stability and returns even during gold price downturns. This is possible thanks to high-profit margins and exposure to a diversified investment portfolio with built-in upside.
Franco-Nevada Corp. (NYSE: FNV) is a gold-focused royalty company with additional interests in silver, platinum, oil, and other resource assets. They have a diversified portfolio of 112 producing assets, 42 advanced assets (not yet producing), and 250 exploration-stage mining properties. FNV generates around 91% of revenues from the Americas and 9% from the rest of the world and has invested $314 million in acquisitions in 2022.
With a global recession seemingly on the horizon, it’s a comfort to shareholders that FNV has zero debt, $2 billion in available capital, and is generating operating cash flow at a rate of $1 billion per year. Thanks to its low-risk/high-margin business model, it’s also largely immune to cost inflation.
Franco-Nevada actively manages its portfolio to maintain a diversity of revenue sources. However, the majority of its stakes are still in gold. In Q3, 77% of revenues were earned from precious metals, with the other 23% mostly coming from energy assets. Their revenue is expected to remain greater than 75% precious metals through 2025.
FNV stock has gained 17% over the past month, and the pros think this is just the beginning. A median price target of $161 represents a 12% upside from the current price. The stock trades at a premium, with a forward P/E ratio of 38, and comes along with a 0.93% annual dividend.
