Gold Royalty Companies - A Shotgun Approach to Gold Investing

A Shotgun Approach to
Gold Investing
By Matt Badiali
May 30, 2008

In the summer of 2007, I traveled to the gold-rich plains of Nevada...

I flew into the tiny Elko, Nevada, airport, which is ground zero for the most prolific gold producing area in the U.S., the Carlin Trend. In fact, I was one of the few folks on the flight not wearing work boots or a company logo'd shirt. At Elko, Joe, my geriatric helicopter pilot, picked me up for an aerial tour of Carlin and its fellow giant deposit, the Cortez Trend.

From the air, the north end of the Carlin Trend looks like a suburban housing development – of gold mines. Most of the mines dotting this region are simply huge holes in the ground (called open-pit mines) but several of the richest mines follow the ore bodies nearly a half-mile underground.

The Leeville Mining Complex, owned by mining giant Newmont Mining, contains one such underground mine. It's part of a huge cluster of mines located on the north end of the Carlin Trend.

The mine I visited, West Leeville, should produce about 400,000 ounces per year for six to eight years... and provide a revenue stream of about $100 million to $150 million at today's gold prices. While Newmont technically owns this stream of gold, another company gets a steady paycheck from that production...

You see, if Nevada were a sovereign nation, it would be the world's third-largest gold producer. The state produced 6.3 million ounces last year, 78% of U.S. gold production, and 12% of the world's production. The heart of Nevada gold production is the Carlin Trend, which has produced more than 50 million ounces since the 1960s.

While Nevada's mining riches are no secret to many investors, few have heard of the gold royalty business. Investing in gold royalty streams gives you a safe and diversified way to participate in the bull market in gold... without risking it all on one big strike or worrying about rising production costs.

You see, building a large gold mine is usually a messy, expensive business.

First, you have to pay geologists to scour the Earth in search of prospective ore bodies – but that's only after paying governments the proper permitting and licensing fees.

Let's say you find a large body of ore after punching hundreds (and often thousands) of exploratory drill holes. Now you have to spend millions on mine infrastructure. This includes roads, mine shafts, electricity, and a smelter. In Newmont's case with the West Leeville mine, it took six years and hundreds of millions of dollars to get it up and running.

One way a producer offsets that cost is by selling a small royalty for the life of the mine. In general, a royalty is simply the right to receive a portion of a mineral resource. It could be oil, gold, copper, or any other commodity.

The mining company gets a lump-sum payment up front, and the royalty investor gets a paycheck for the life of the mine. A royalty company may make hundreds of small investments to spread its risk and even out future payments. The royalty company then distributes a small portion of its paychecks to shareholders through dividends and invests the rest in new projects.

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Investing in royalty companies is like taking the shotgun approach to mining. You get many small chances to participate in exploration, so you have the potential of a big discovery. In addition, you have minimal risk and you get a paycheck for the risk you do take.

I believe gold's bull market will last a long, long time... and the more gold rises, the more money these royalty companies will make. If you don't own any gold stocks, and you're not sure how to get started, gold royalty companies are a fantastic option for the conservative investor.

Good investing,

Matt

Editor's note: Matt Badiali is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.

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THE CORRUPT WAY TO OWN COMMODITIES

Early this week, we introduced the idea of buying the ABCs – Australia, Brazil, and Canada – as a way to own commodities for the long term. Several DailyWealth readers wrote to ask, "Great... but what about Russia?"

Two things about Russia: One, the country has extraordinary resource wealth. It's the world's second-largest producer of crude oil. It's the largest producer of natural gas. It has huge stores of timber, diamonds, and minerals. Two, Russia is new to this "capitalism thing." Most who have done business there believe the government is as crooked as a dog's hind leg.

This corruption makes Russia a more speculative way to own commodities than say Australia or Canada. But it's a speculation the market likes right now. Let's look at Central Europe and Russia Fund (CEE). This ETF is one of the most liquid ways to buy Russian stocks. A big chunk of the fund is in Gazprom, the world's largest natural gas company. Monster base-metal miner Norilsk Nickel also carries a large weighting.

The bull market in resources has helped the CEE gain 450% in the past five years. As you can see from today's chart, Russia may be corrupt, but in a world of $130 oil, the market is saying, "Who cares about corruption? Just give me a good commodity play."

Central European Eqty Fund

The United States is already in a recession and it will be longer as well as deeper than many people expect, U.S. investor Warren Buffett said in an interview published in German magazine Der Spiegel on Saturday.

He said the United States was "already in recession" and added: "Perhaps not in the sense that economists would define it" with two consecutive quarters of negative growth.

"But the people are already feeling the effects," said Buffett, the world's richest man. "It will be deeper and last longer than many think."

But he said that won't stop him from investing in selected companies and said he remained interested in well-managed German family-owned companies.

"If the world were falling apart I'd still invest in companies," he said.

– Reuters

Over the past seven years, according to Citibank, Russia accounted for 80% of the growth in oil production outside the Organisation of the Petroleum Exporting Countries. The increase in its output in the early part of the decade matched the growth in demand from China and India almost barrel for barrel.

In principle, Russia's bonanza could continue for years: it has the world's seventh-biggest oil reserves, at 80 billion barrels, according to BP, a British oil firm. And oilmen reckon there are 100 billion more barrels to find – "the biggest exploration prize in the world", in the words of Robert Dudley, the boss of TNK-BP, BP's Russian joint venture. But Russia has regulated the industry so poorly that production is falling despite the soaring oil price.

"Tax is the major impediment," says Ms Redman. The government levies an export duty of 65% at prices over $25 a barrel. Add to that various corporate, payroll and production taxes, oilmen complain, and the state creams off as much as 92% of profits.

– The Economist

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