What is a Gold Royalty?
A Gold Royalty is simply a contract between an investing company and a gold mining company that gives the investor the right to a percentage of gold production or revenues in exchange for an upfront payment. The advantage to the mining company is an alternative form of financing that provides the miner with capital that they don’t need to pay back until production begins.
Between 2008 and 2018, royalties and streams contributed over $26 million to total mine financing.
This alternative form of mine financing is usually more attractive than traditional debt or issuing equity. Gold royalty companies often purchase pre-existing royalties as a way to build a diversified portfolio of royalty assets. Since royalties typically cover the life of a mine, gold royalty companies benefit from the exploration upside that may extend the life of the mine and thus increase the amount of gold (or revenue) they receive from the mining company at no additional cost. In general, gold royalty companies are cash generating machines with little overhead.
How The Financing Is Used
When gold is discovered, there are a number of things that must happen before the mine can generate cash-flow.
The first thing to do is determine whether the mine is worth it or not, and that means exploration. This includes rock sampling, geological mapping, and drilling the property for samples. Tests are done to determine the viability of the future mine.
If all goes well and the mine is determined to have value (it can make money with acceptable costs), the the project moves to development, which requires a great deal of capital, which is partially funded through royalty and streaming financing.
Once development is complete, the project moves into production and the mine starts producing gold and the royalty and streaming companies start reaping what they sowed.
The mining company sells refined gold produced from the mine, and writes a check for a percentage of the revenue or profit to the royalty. The stream company receives a percentage of the gold at a predetermined discount, and then sells the gold at market price.
Two Common Royalty Types
The are several types of royalties, but the two most common are NSR and NPI royalties.
A Net Smelter Returns (NSR) royalty is an agreement where the mining company agrees to pay a percentage of the revenue less refining costs.
A Net Profits Interest (NPI) is an agreement to pay the royalty company a percentage of the profit from the mine.
What is a Stream Company?
A stream is a contract where the mining company agrees to sell the stream owner a set percentage of the physical metal produced. The stream contract specifies either a fixed price per ounce (set at a much lower than current gold spot price) or a percentage of the gold spot price. The Stream company makes money by selling the gold for a profit at the current market value.
The first precious metal streaming contract was created by Wheaton Precious Metals in 2004. Wheaton purchased the full silver rights to Goldcorp’s San Dimias gold and silver deposit in Mexico for an upfront payment of nearly $400 million. Since that deal went through, gold royalty and streaming companies have grown exponentially, with a combined market cap of #33 Billion at the end of 2018.
Traditional debt can be a major burden for mining companies. Not only is it difficult to get when gold markets are in a down cycle, but issuing equity to raise capital reduces shareholder value, and acquiring too much debt has been the cause of many bankruptcies.
Over the last 10 years, the gold royalty sector has outperformed gold and gold mining companies, even in a gold bear market. And this was especially true since the market drop caused by the Coronavirus pandemic. Royalty and Streaming companies have been on fire. And this is why we concentrate so heavily on them now.