October 11, 2017 / 9:56 AM / a year ago

Cautious investors still favouring gold royalty companies over miners

LONDON (Reuters) - Investors in precious metals are opting for streaming and royalty companies over pure gold and silver miners this year despite a rise in metal prices, as producers struggle to win confidence in their ability to capitalise on the rally.

Streaming and royalty companies provide financing for exploration and development to precious metals producers in return for a cut of any future output. That gives them exposure to a range of companies in the gold sector, rather than being reliant on any individual stock.

The model makes them a nominally safer bet for investors, but gives them lower leverage to a strong rise in underlying gold prices.

Among the biggest streaming companies, shares in Toronto-based Franco-Nevada (FNV.TO) are up 24 percent and Royal Gold Inc (RGLD.O) is 40 percent higher this year, while among smaller names, Osisko Gold Royalties (OR.TO) has risen 25 percent.

But even with an 12 percent bounce in gold XAU= this year, the FTSE Gold Mines Index .FTGM, which represents mining companies, has risen just 10 percent. Gold mining stocks are historically leveraged at two or three to one to the gold price.

Streaming companies’ higher net asset value shows how much more favourably investors view their risk profile compared to those of the underlying mining companies, Keith Watson, co-fund manager for City Natural Resources High Yield Trust, said.

“Lots of people are prepared to pay a premium for something that doesn’t necessarily have the same level of operating and financial risk as would an underlying miner,” he said.

“It is quite telling, the value, for relatively few ounces in comparison, of the collective basket of streaming companies, compared to the collective basket of companies from which they stream.”

Gold producers’ failure to capitalise on rising prices has been a familiar gripe over the last 15 years. While gold prices, despite their retreat from 2011’s record high, are still up more than fourfold from end 2001 levels, none of the top five gold miners has even doubled its share price in that time.

New York-based Paulson & Co, a longtime investor in precious metals, became the latest to criticise gold mining companies’ poor returns, calling at the Denver Gold Forum last week for action to tackle miners’ “dreadful” performance.

The dividend yields of the major mining companies, a measure of the productivity of an investment, have fallen back sharply since the steep drop in gold prices of 2013. Those of streaming companies have held firm.

Arnaud du Plessis, portfolio manager at CPR Asset Management, which has $300 million invested in the gold mining sector, says his fund has progressively lifted exposure to the gold streaming sector, to around 16.5 percent from 10 percent a year ago.

“Since the all-time high of September 2011, gold prices are still down something like 30 percent. Gold mining companies are down by nearly 60 percent. Franco-Nevada recently just hit a new all time high,” he said.

“The structure offers huge diversification in terms of risk, and a lot of opportunities in terms of exposure to gold prices and production improvement, without exposure to cost inflation.”

But while risks may be diversified, investment in gold streaming companies still gives, in theory, less exposure to rising gold prices than an investment in a mining company.

With gold prices up this year, and expected to extend gains for a third year in 2018, the mining companies should look more attractive. But that has not happened in practice.

“We have not seen that leverage play out this year,” BMO Capital Markets analyst Andrew Kaip said. “A lot of that has to do with stumbles that took place in 2016. There have been a number of smaller companies that have had operational issues that have impacted their performance, and largely speaking the bigger gold miners have been viewed as fully valued.”

In this environment, the more defensive streaming companies are still attractive.

Reporting by Jan Harvey, editing by David Evans

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