The Armchair Trader starts a new series in partnership with E.B. Tucker on gold investing
Gold has been a store of value for nearly the entire history of human civilization. Gold is scarce, durable, versatile and tangible. As such, it maintains its value and is considered a safe haven investment. Back in 500BC the fabulously-wealthy King Croesus was minting coins, and in the nineteenth century the Gold Standard was introduced.
More recently financial markets have recommended gold as a safe haven in bad economic climates, and quite propitiously long-time Florida-based mining investor, E.B.Tucker has penned a book on investing in the commodity during economic downturns, which he has shared with The Armchair Trader.
In the next four weeks we will be running excepts from the book as a series on gold investing. This week E.B. Tucker looks at the investment proposition that is gold royalty companies. Buy cheap, don’t get your hands dirty and reap vast profits. It’s all about
Simply, Gold is the most profitable business in the world a fact illustrated by Franco Nevada Corporation. USD2m in and USD1bn out. That’s 500-times the initial investment. Those are real numbers, audited, and owned by shareholders of what I call: “the world’s most profitable business.”
Franco Nevada is one of the world’s leading gold royalty companies. Royalties don’t just belong to kings and queens, miners – or mining financiers – get them as well. There’s no dirty work involved – it’s just a case of clipping 1% or 2% off the top. So, if 100oz of gold comes out of the ground, the royalty owner gets one of those ounces at no cost outside of the initial price paid for the royalty. In the mid-1980s the two men who put Franco-Nevada together came to the same conclusion: hunting for the next great gold mine is a racket. You might get lucky and actually find something. You might get a lift out of a gold market bull run, but generally you’ll need some kind of happy accident to avoid going bankrupt every two years.
Franco talked about the idea of buying a few royalty claims to generate income. This steady cash flow coming in the door would keep the company afloat. One of the founders mentioned it to consultants helping the company in 1985.
A few months later, one of the consultants called up and asked the company if they would pay him a finder’s fee for a tip on a royalty for sale. The company agreed. The consultant produced a copy of a classified ad from a local Nevada newspaper advertising a royalty for sale. Franco paid USD2m for the royalty. It paid the consultant USD90,000 for the classified ad.
The royalty covered 3,416 acres of dusty land in Northeastern Nevada. Elko is the closest major town about one hour east. A Texas-based oil company owned the royalty but had to sell it due to financial trouble.
West of Elko, several companies found gold known as ‘Carlin-type’. It’s a kind of grade deposit where it’s almost too hard to see the gold. There were clusters of similar finds in the area, and this was what was in the ground in the area of Franco’s newly-acquired royalty.
Owning a royalty means a mining company prospects for gold on the property where you have a claim to a small part of every ounce found. Once production begins, 1% or 2% of everything produced flows directly to the royalty holder. The royalty-holder doesn’t get involved in digging or exploration. Franco Nevada got lucky. The mining company working on its royalty discovered what is today one of the richest seams of Carlin-type gold in the world producing more than 45moz. It’s still in production and paying out today. The royalty business is the most lucrative I know of, and Franco is its blue-chip leader. It has hundreds of royalties under management – but only employs 26 people.
Optionality
The secret of the royalty business is optionality. That means buying something with unlimited potential and minimal effort on your part to realize it. In this business the trick is buying royalties near existing deposits as geologically gold manifests itself in clusters. You strike gold in one place, it’s likely there is more nearby.
In the end it becomes a numbers game as you need to buy as many royalties as you can, in the hope that one will hit paydirt. With hundreds of royalties spread across the world Franco has optionality at its core. Investors who bought Franco stock in the 1983 IPO did very well. In his book Get Smarter, one of the founders, Seymour Schulich, said USD1,000 invested in the 1983 turned into USD1.25m by early 2004 when Newmont acquired the company.
Franco came back to the public markets in late 2007. Between then and the end of 2020, the gold price went up 111%, but Franco Nevada went up 823%, not including dividends.
Gold royalties are the best bet on higher gold prices I know. Naysayers complain about royalty stocks. They say the stocks are too expensive. They say you miss out on the potential for a huge new gold discovery. They’re right on both counts.
Expensive
Royalty stocks are expensive. As with most things in life, you get what you pay for. A USD0.10 share mining stock with the chance at a big discovery only needs your money to roll the dice. With 99 out of 100 failing to produce anything other than mounting losses, the risk on the USD0.10/share stock is high. I say that makes the miner more expensive than a royalty stock.
Franco Nevada started out as an explorer, but the firm quicky realised that it would be stuck in a cycle of selling stock to finance exploration, which would erode the value of the company. If it ever found anything, the company would only own a spall part, and that was the rationale to switching to the royalty business.
A royalty claim represents a perpetual, non-dilutable, free carried interest in a mineral asset. Once you acquire the claim, there’s not much ongoing work. Perpetual means the royalty interest in a mineral claim goes on forever. Most are permanent, some cover time periods. Either way, the claim remains through tough years in the gold market. When a company picks back up and resumes looking for gold, the royalty is still there.
There are only six pure-play royalty companies today, excluding smaller and still unproven companies, or those that dabble in mining. What I realised over time is that mining as a business and a stock pick is a terrible idea. However, the royalty business is a different prospect, and that’s why I got in on the ground and joined Metalla Royalty & Streaming as a director in its early days.
The royalty business is not easy – it’s a relationship business. Royalties are hard-to-find and there are no matchmaking apps or websites that advertise them. But if you are looking to make money from gold – they are the kings of finding paydirt.
E.B. Tucker sits on the Board of Directors at Metalla Royalty & Streaming #and Nova Royalty Corporation and is director of Midas Capital Partners.
