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Royalty and Streaming Companies May Underperform as Gold Rises

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Royalty and streaming companies

The business models of royalty and streaming companies is quite different from those of other precious metals miners. Unlike other precious metals companies, royalty companies don’t own mines. They make upfront payments in return for the purchase of fixed percentages of future silver or gold mine production. As mine owners deliver precious metals to royalty and streaming companies, additional payments are made to them.

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 mines at fixed costs. 

Afterward, if the producer expands its output by spending more money, royalty companies stand to benefit. For this reason, these companies are usually less risky than mining companies.

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Relative price performance

This model offers protection to investors in times of low prices because they have fixed costs. 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 falling precious metals prices, and vice versa.

Royalty companies have returned 90% YTD (year-to-date) as of September 21, 2016, compared to GDX’s 98% return. Investors should note, however, that these companies are still levered plays on gold. Gold prices have returned 24% YTD compared to royalty companies’ returns.

Correlation to gold prices

Of all the sub-categories of precious metal miners, royalty and streaming companies have the lowest correlations with gold. From 2013 to September 21, 2016, royalty companies have shown a correlation coefficient of just 0.57.

Franco-Nevada (FNV), Silver Wheaton (SLW), Royal Gold (RGLD), and Osisko Gold Royalties (OKSKF) currently make up 13.8% of the VanEck Vectors Gold Miners ETF’s (GDX) holdings. Note that bigger royalty companies such as FNV and SLW are more diversified, while smaller ones such as Osisko and SandStorm Gold (SAND) still face mine risks due to their limited diversifications.

Now let’s explore whether silver equities could see higher returns than gold equities in the current market environment.

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