The business model of royalty/streaming companies is quite different from that of other precious metal miners. Unlike other precious metals companies, royalty companies don’t own mines. They make an upfront payment in return for a purchase of a fixed percentage of the future silver or gold production from a mine.
Royalty companies then sell the gold and silver production they receive from these streaming contracts at market prices. These contracts give royalty companies access to the metal streams for the life of the mine at fixed costs. After that, if the producer expands output by spending more money, royalty companies stand to benefit. For this reason, these companies are usually less risky than mining companies.
Relative price performance
This model offers protection to investors in times of low prices because of the fixed costs. Such companies usually are diversified across various projects from different miners. Since they don’t participate in mining costs directly, they have lower leverages to gold and silver prices. As such, they outperform miners in times of low and declining precious metal prices, and vice versa.
This could explain why royalty companies have returned only 82% YTD (year-to-date) as of July 25, 2016, as compared to GDX’s 100% return. Investors should note, however, that they are still a levered play on gold. Gold prices have returned 22% YTD in comparison to royalty companies’ 82% return.
Correlation to gold prices
Of all the sub-categories of precious metal miners, royalty and streaming companies have the least correlation to gold. For the period starting 2013 until July 25, 2016, royalty companies have shown a correlation coefficient of just 0.60.
Franco-Nevada (FNV), Silver Wheaton (SLW), Royal Gold (RGLD), and Osisko Royalties (OKSKF) currently make up 14.8% of the VanEck Vectors Gold Miners ETF’s (GDX) holdings. We should note here that bigger royalty companies such as FNV and SLW are more diversified while smaller ones such as Osisko and SandStorm (SAND) still face mine risks due to their limited diversification.
Now let’s explore what’s causing the spike in silver equities.