Gold royalty companies and bitcoin – a viewpoint

Here at lawrieongold.com we have long advocated the investment positives of precious metals royalty companies – and Franco Nevada and Royal Gold have been the two best performers so far this year out of the precious metals stocks we recommended on Seeking Alpha right at the end of 2016 – See: 2017 Predictions – Gold, Silver, PGMs, The Dollar, Markets, Geopolitics,

However we do have to say that on bitcoin we are not really a believer.  To us there is no underlying value, it is in a bubble, and will likely, at some stage, come crashing down from whence it came – but Frank Holmes. whose thoughts we publish below is very definitely a believer reckoning that it is a currency for our times and is being taken up particularly by millennials.  As I say, we are not so sure but Frank’s views are well worth reading.  After all he runs a successful series of funds, while I do not!  Anyway, do read Frank’s views on the royalty companies and bitcoin below:

My Conviction in Gold Royalty Companies and Bitcoin

By Frank Holmes – CEO and Chief Investment Officer, US Global Investors

Bitcoin

Some of you reading this might already be familiar with the “Parable of the Talents,” but it’s worth a brief retelling. The story, which appears in the gospels of Matthew and Mark, involves a master who entrusts three servants with some of his “talents,” or gold coins, while he’s away on business. Two of the servants take a risk by putting the money to work and end up doubling their master’s wealth. The third servant, however, buries his share to “keep it safe” and so doesn’t generate any returns. (Indeed it likely loses value because of inflation.)

When the master returns, he’s so pleased at how the first two servants grew his wealth that he puts them in charge of “many things” and invites them to share in his own success.

The third servant, though, he calls “wicked and lazy” and says he might as well have deposited the money in a bank while he was away—at least then he would have received a little interest. The servant is punished by having his share of the talents given to the two who faithfully grew their master’s money, leaving him with nothing.

The lesson here should be plainly obvious, and we can express it in a number of different ways: There can be no reward without risk. You must spend money to make money. You reap what you sow. This should resonate with investors, entrepreneurs and any true believer in the power of capitalism.

Jesus’ parable applies not just to individuals but to corporations as well. Companies must grow to keep up with the rising cost of labor and materials and to stay competitive. To do that, they must put their money to work just as the two servants do.

And just as the two servants were invited to share in their master’s success, corporate growth has a multiplier effect—for the company’s employees and their families, shareholders, the local economy, strategic partners, companies up and down the supply chain and much more.

A Bonanza for Precious Metal Royalty Companies as Exploration Budgets Have Declined

I think the business model that best illustrates the meaning of the “Parable of the Talents” is the one practiced by gold and precious metal royalty companies. As much as I write and talk about royalty companies, I still encounter investors who aren’t aware of how significant a role they play in the mining space.

As a refresher, these firms help finance explorers and producers’ operations by buying royalties or rights to a stream. Because miners have had to slash exploration budgets since the decline in metal prices, the kind of financing royalty companies provide has only grown in demand—as evidenced by the mostly positive earnings reports last week.

Chief among them is Franco-Nevada, which had a very strong third quarter, reporting earnings of $55.3 million, or $0.30 a share, up 3.4 percent from the same three-month period last year. The Toronto-based company, having also recently diversified into the oil royalties space, closed its purchase of an oil royalty for C$92.5 million, bringing the number of its oil and gas assets up to 82. Including precious metals and other minerals, the total number of assets Franco-Nevada had in its diverse portfolio as of the end of the quarter stood at 341.

Here’s the multiplier effect: Not only do the miners benefit from the deals, allowing them to continue exploration and other operations, but shareholders are also rewarded handsomely. Since the company went public nearly 10 years ago, it’s raised its dividend each year and its share price has outperformed both gold and relevant gold equity benchmarks. After its earnings announcement last Monday, Franco-Nevada stock closed up more than 6 percent on the New York Stock Exchange (NYSE), its best one-day performance in nearly a year and a half. Shares hit a fresh all-time high last week.

Precious metal royalty names have outperformed gold and gold producers
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Other royalty companies’ reports were just as impressive and show the rewards of putting your “talents” to work. Sandstorm Gold, reporting higher operating cash flow of $11.9 million, has acquired as many as 10 separate royalties since the end of September on properties in Peru, Botswana and South Africa that collectively cover more than 2.4 million acres.

Osisko Gold Royalties bought a $1.1 billion portfolio of 74 precious mineral royalties, including a 9.6 percent diamond stream. The company reported record quarterly gold equivalent ounces (GEOs) of 16,664, up 65 percent from the same quarter last year, and record quarterly revenues from royalties and streams of $26.1 million, up 48 percent.

Royal Gold also had a strong quarter, reporting operating cash flow of $72 million, an increase of 30 percent from last year, and returned as much as $16 million to shareholders in dividends.

Wheaton Precious Metals, the world’s largest precious metal streaming company, showed a sizeable decline in profits in the third quarter, but it continued to generate strong cash flow and looks poised to meet its end-of-year production guidance.

Although some investors might not realize how important these companies are to the industry, many other investors are opting to place their bets on royalty names, seeing them as having ample exposure to precious metals without some of the risks associated with producers. In its review of the third quarter, the World Gold Council (WGC) reported that global gold demand fell to an eight-year low as investment in gold ETFs slowed to 18.9 metric tons, down from 144.3 metric tons in last year’s September quarter. This could be a consequence of the media’s continued negative coverage of gold, despite its competitive performance against the S&P 500 Index. Whatever the cause, in this environment, there was no lack of love for royalty names, as you can see in the chart above.

A Changing Financial Landscape

We were one of Wheaton Precious Metals’ seed investors in 2004, when it was then known as Silver Wheaton. Because Franco-Nevada wouldn’t be spun off from Newmont Mining for another three years, Wheaton had first-mover advantage. It was something new, something different. This, coupled with what I recognized as a superior business model, gave me the conviction to allocate capital into the fledgling company, a move that turned out to be highly profitable.

Today I have the same conviction in blockchain technology and digital currencies. As of the end of October, the initial coin offering (ICO) market had raised $3 billion so far this year. That’s more than seven times the amount generated in crowdfunding in all of the previous years before 2017. And Bloomberg just reported that Google searches for “buy bitcoin” recently surpassed searches for “buy gold.”

Search queries for buy bitcoin surged past buy gold
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With bitcoin’s market cap having grown past that of Goldman Sachs and Morgan Stanley, cryptocurrencies can no longer be written off as a curiosity. Major financial institutions have become bullish, having filed approximately 2,700 patents in blockchain technology.

Abigail Johnson, the youthful chairman of Fidelity, was quoted as saying, “Blockchain technology isn’t just a more efficient way to settle securities, it will fundamentally change market structures, and maybe even the architecture of the internet itself.” Johnson allegedly has a crypto-mining computer rig in her office, and Fidelity accountholders are now able to see their bitcoin holdings on the brokerage firm’s online platform. USAA, the massive financial firm used by millions of U.S. military personnel and their families worldwide, provides a similar service.

Bitcoin

This all comes as Coinbase, a leading digital currency broker, saw a record number of people opening new accounts on its platform recently, doubling the number of accounts from the beginning of the year. In one 24-hour period, 100,000 new accounts were opened.

Millennials Driving Interest in Blockchain Technology and Cryptocurrencies

A lot of this growth in demand is thanks to millennials, the largest U.S. generation. Forget the stereotype of the “entitled” millennial in the workplace and the misconception that they’re all wasting their money on $10 avocado toast. Consulting firm Deloitte estimates that by 2020, millennials will make up 50 percent of the workforce and control between $19 trillion and $24 trillion. Many are savvy investors and were found to be more likely to be aware of their brokerage account fees than older generations, according to Charles Schwab’s Modern Wealth index.

In some ways, millennials are reshaping our living habits. Many of them choose to rent instead of own to stay mobile. They’re more likely to get their news from Twitter than from TV. Online dating apps have helped foster today’s hookup culture, but while young people now might have more sex partners than before, they’re having less sex overall than their parents or grandparents might have had at their age.

It’s little surprise, then, that millennials are among the earliest and most enthusiastic adopters of blockchain technology, bitcoin and digital currencies in general—none of which existed even 10 years ago. A poll conducted by Blockchain Capital found that large percentages of millennials would prefer $1,000 in bitcoin to $1,000 in other assets. More than a quarter said they would prefer bitcoin to stocks, while nearly a third preferred it to bonds.

Percent of millenials who would prefer 1000 in botcoin to 1000 in
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What I find especially encouraging is that only 4 percent of those who took the poll owned or had owned bitcoins. I say encouraging because this suggests there’s quite a lot of upside potential for bitcoin ownership, which in turn could raise prices further. As I shared with you recently, Metcalfe’s law states that the bigger the network of users, the greater that network’s value becomes. Consider Facebook. The social media giant has more than 2 billion active users. That’s 2 billion pairs of eyes Facebook is able to charge top dollar for advertisers to reach, helping it deliver record profits in the third quarter.

We could see the same thing happen across the blockchain and cryptocurrency network as more and more businesses and people embrace this new form of exchange.

Ploughing Capital into Blockchain

It should be clear by now that something is changing in financial markets, and this is what inspired me to make a strategic investment in a company with first-mover advantage in the cryptocurrency space, just as we did with Silver Wheaton years ago. As the “Parable of the Talents” teaches us, no reward can come to you without some risk-taking. Doing nothing is not an option.

That company is HIVE Blockchain Technologies, a blockchain infrastructure company involved in the mining of virgin digital currencies. The first company of its kind to sell shares to the public, HIVE began trading on the TSX Venture Exchange on September 18.

I’m very excited about this new chapter in our company’s history. If you weren’t on today’s earnings call, you can download the slide deck here to learn more about our deal with HIVE and what it means for our investors and shareholders.

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The Top Six Things You Should Know About Royalty Companies Now

By Frank Holmes – CEO and Chief Investment Officer US Global Investors

franco nevada royalty companies big truck

While in New York last week, I had the privilege of seeing many colleagues face-to-face. It’s always a pleasure for me to be able to talk gold with industry friends and experts. One stop during my trip that I thoroughly enjoyed was to chat with Pimm Fox and Lisa Abramowicz on Bloomberg Radio. Our discussion was dynamic as always and I shared with them my outlook for gold in the second half of the year, along with the opportunities I continue to see with royalty names.

discussing gold with lisa abramowicz and pimm fox at bloomberg radio

I still find it curious that many investors don’t realize what a significant role royalty and streaming companies play in the mining business.

Last year I wrote about some of my favorite royalty names, and how I came to know about this business model in the gold mining industry early in my career. If you haven’t read that blog post, I encourage you to go back and explore the groundbreaking work done by Seymour Schulich and Pierre Lassonde, the two founders of Franco-Nevada.

I think that now is a good time to take another look at royalty companies. Here are the top six things I believe investors should know about this specialized sector.

1. What Is a Royalty Company?

Royalty companies, sometimes called streaming companies, serve a special role in the mining industry. Developing a mine property to start producing gold or other precious metal is an expensive, often time-consuming process. Infrastructure needs to be built out, permits applied for, laborers hired and more.

A royalty company serves as a specialized financier that helps fund exploration and production projects for cash-strapped mining companies. In return, it receives royalties on whatever the project produces, or rights to a “stream,” an agreed-upon amount of gold, silver or other precious metal.

bhow does the royalty and streaming financial work
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2. Many Gold Royalty Companies Have Still Been Outperforming Gold

When looking over the last 12 months, many of the royalty companies have outperformed gold. While this is indeed remarkable, it is important to remember that royalty companies do have a robust business model. Their ability to generate revenue in times when the gold (or other precious metal) price is both rising and falling is what makes them attractive.

royalty companies outperformed gold
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3. Remember Real Interest Rates

There’s no question that the gold price is volatile, and in any given 12-month rolling period, historically it’s not unusual for the price of the yellow metal to fluctuate up or down by 20 percent. It’s important for investors to remember that gold historically shares a strong inverse relationship with real interest rates. You can see in the chart that as rates rise, the price of gold falls, and vice versa.

gold historically shares an inverse relationship with real rates
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This is another reason why I like the royalty model. Since royalty companies set fixed, lower-than-market prices for mining output, they can better manage the volatility that is inherent in the gold market. For example, Wheaton Precious Metals’ 19 agreements in 2016 entitled the company to buy silver at an average price of $4.42 an ounce and gold at $391 an ounce.

4. Speaking of Revenue

Last time I wrote about these companies, I shared with you that the three big royalty names boast impressive sales per employee. This is still true. Take a look at the 12-month revenue per employee of Franco-Nevada, Royal Gold and Wheaton Precious Metals. Wheaton has only around 30 employees, but has one of the highest rates in the world, generating $25.8 million per employee. By comparison, Newmont, which employs around 30,000 people, generated $310,000 per employee during the same period. Barrick also falls short by comparison.

royalty companies have greater revenue per employee model than procedures
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5. Friendly to Shareholders

Paying dividends is important to investors, as it reflects the health of a company in terms of its cash flow and profits. Even more favorable in the eyes of investors is a company that is growing its dividends. Between 2012 and 2017, royalty companies had a combined annual dividend growth rate of 17 percent. Compare that to 11 percent growth for the S&P 500 Index, and as low as negative 23 and negative 32 percent for global and North American precious metal miners.

royalty companies dividend rates have been growing
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In fact, 2017 marks Franco-Nevada’s 10th straight year of dividend increases since the company went public in 2007.

6. Less Reliance on Debt

Royalty companies are better allocators of capital than some of the biggest gold miners. Take a look at Newmont Mining, which has a 43 percent debt-to-equity ratio, and Barrick has a massive 91 percent. By comparison, many of the royalty companies have much lower debt, and Franco-Nevada has zero debt. This history of profitability and fiscal discipline is one of the main reasons I find royalty companies so attractive.

royalty companies have less debt
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Silver Wheaton: The Ultimate Streaming Service

Frank Holmes, CEO and Chief Investment Officer for U.S. Global Investors expounds on the methodology employed by streaming company, Silver Wheaton, which he views as one of the lowest risk ways of investing in the upturn in precious metals stocks:

Silver Wheaton CEO Randy Smallwood (right) with USGI portfolio manager Ralph Aldis

“There’s a healthy appetite for streams right now.”

That’s according to Randy Smallwood, CEO of Silver Wheaton, who stopped by our office last week during his cross-country meet-and-greet with investors.

Randy should know about the appetite for streams. His company had a phenomenal 2015—“the best year we ever had,” he says—highlighted by two successful stream acquisitions, strong production and fully-funded growth. Silver Wheaton stock is up more than 51 percent for the year. And the company just received the Viola R. MacMillan Award, presented by the Prospectors & Developers Association of Canada (PDAC), for “demonstrating leadership in management and financing for the exploration and development of mineral resources.”

We were one of Silver Wheaton’s seed investors in 2004. In the summer of that year, the company was spun off from Wheaton River, a producer that took its name from a stream in the Yukon where one of its mines, the Luismin property, produced silver. It was founded by Ian Telfer, chairman and CEO of Wheaton River, and the company’s then-chief financial officer, Peter Barnes, who later headed up Silver Wheaton management. My friend, the mining financier and philanthropist Frank Giustra, also had a hand in its conception.

As the only pure silver mining company, Silver Wheaton couldn’t have been founded during a more opportune time. The commodities boom was still young. I remember that when the idea for the company was shared with me, what I found most attractive was that it had virtually no competition.Franco-Nevada, which had been acquired by Newmont in 2001, wouldn’t be spun off for three more years. It was a no-brainer to put capital in this new endeavor.

Wheaton River was eventually bought by Goldcorp—the entire story is told at length in the book “Out of Nowhere: The Wheaton River Story”—and today, Silver Wheaton is the world’s largest precious metals streaming company, with a market cap of over $9 billion.

But Wait, What’s a “Stream”?

A “stream,” in case you were wondering, is an agreed-upon amount of gold, silver or other precious metal that a mining company is contractually obligated to deliver to Silver Wheaton in exchange for upfront cash. (The company’s preferred metal is silver because, as Randy puts it, it’s a smaller market and has a higher beta than gold.) The payment generally comes with less onerous terms than traditional financing, which is why miners favor working with Silver Wheaton (or one of the other royalty companies such as Franco-Nevada, Royal Gold and Sandstorm.)

Overview of Royalty and Stream Financial Model
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Streaming allows producers to “take the value of a non-core asset and crystallize that into capital they can invest into their core franchise,” Randy explains in a video prepared for the PDAC awards.

With operating costs mounting and metals still at relatively low—albeit rising—prices, royalty and streaming companies have become an essential source of financing for junior and undercapitalized miners. Between 2009 and 2014, operating and capital costs per ounce of gold rose 50 percent, from $606 to $915 per ounce, according to Dundee Capital.

Gold and Silver at 15-Month Highs

Paradigm Capital estimates that between 80 and 90 percent of global miners’ operating costs are covered when gold reaches $1,250 an ounce. The metal is now at this level—it’s currently at $1,298, up 22 percent so far this year—but as recently as December, prices were floundering at $1,050, which cut deeply into producers’ margins.

Royalty and streaming companies, on the other hand, get by with a materially lower cost of $440 an ounce.

From only 11 stream sales in 2015, miners collectively raised $4.2 billion, which is double the amount they raised in 2013.

These partnerships are a win-win. The miner gets reliable, hassle-free funding to cover part of its exploration and production costs, and the streaming company gets all or part of the output at a fixed, lower-than-market price. A 2004 streaming arrangement made with Primero on the San Dimas mine in Mexico entitles Silver Wheaton to buy all of its silver for an average price of $4.35 an ounce. With spot prices now at more than $17.89 an ounce, up 29 percent year-to-date, the San Dimas property is one of Silver Wheaton’s more lucrative assets. (The mine represents an estimated 15 percent of Silver Wheaton’s entire operating value, according to RBC Capital Markets.)

As part of its contracts, Silver Wheaton gets the added value of optionality on any future discoveries. This is important, since an estimated 70 percent of all silver comes as a byproduct of other mining activity, including gold, zinc, lead and copper. According to Randy, all of Silver Wheaton’s silver is byproduct.

Seventy Percent of Silver Is a Byproduct of Other Mining Activity

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Huge Rewards, Minimal Risk

Investors find royalty companies such as Silver Wheaton attractive for a number of reasons, not least of which is that they have exposure to commodity prices but face few of the risks associated with operating a mine.

They have minimal overhead and carry little to no debt. Franco-Nevada, in fact, added debt for the first time ever last year to buy a stream from Glencore. By year-end, the company had already paid down half this debt, and it plans to tackle the rest this quarter.

Royalty companies also hold a more diversified portfolio of mines and other assets than producers, since acquiring new streams doesn’t require any additional overhead. This helps mitigate concentration risk in the event that one of the properties stops producing for one reason or another.

Royalty Companies Hold a More Diversified Portfolio of Assets

Consequently, margins have historically been huge. Even when the price of gold and gold mining stocks declined in the years following 2011, Franco-Nevada continued to rise because it had the ability to raise capital at a much lower cost than miners. And with precious metals now surging, royalty companies are highly favored, with Paradigm Capital recommending Franco-Nevada, which has “exercised the most buying discipline among the royalty companies,” and the small-cap, highly diversified Sandstorm.

Gold Royalty Company vs. Gold Bullion vs. Gold Miners
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With only around 30 employees, Silver Wheaton has one of the highest sales-per-employee rates in the world. According to FactSet data, the company generates over $23 million per employee per year. Compare that to a large senior producer like Newmont, which generates “only” $200,000 per employee.

Royalty Companies Have a Superior Business Modelclick to enlarge

Royalty companies can often minimize political risk because they don’t normally deal directly with the governments of countries their partners are operating in. This is especially valuable when working with miners that operate in restrictive tax jurisdictions and under governments with high levels of corruption. Silver Wheaton’s contract with Brazilian miner Vale, for instance, stipulates that Vale is solely responsible for paying taxes in Brazil, which are among the highest in Latin America. Vancouver-based Silver Wheaton pays only Canadian taxes.

Political risk is still a thorny issue, however. When government corruption is too pervasive, or the red tape too tortuous, the miner’s corporate guarantee is obviously threatened. In cases such as this, Silver Wheaton can simply elect not to work with the producer, as it had to do recently with an African producer.

A key risk right now is Silver Wheaton’s ongoing legal feud with the Canadian Revenue Agency (CRA), regarding international transactions between 2005 and 2010. Randy says the company might finally be nearing a resolution to the dispute.

“We do have resource risk. We do have mining production risk,” he says. “But with that risk comes rewards, and I think if we’re selective in terms of our investments, the rewards far outweigh the risks. I think we’ve been really successful making sure we invest in good quality, high-margin mines. We really put a strong focus on mines that are very profitable.”