Mining can be a risky business…
Finding, building, and operating a mine is tough. With gold prices down this year, many large gold producers are struggling to make a profit. And their share prices are suffering.
The popular gold miner I urged you to avoid in February, Newmont Mining (NEM), is down around 20% this year. And the benchmark Market Vectors Gold Miners Fund (GDX) is down around 15%.
But there’s one type of gold “mining” stock up double-digits this year… and there’s more upside ahead.
[ad#Google Adsense 336×280-IA]Let me explain…
As I said earlier, building a gold mine is an expensive and risky proposition.
To start, you have to pay geologists to scour the world in search of prospective ore bodies. Then you have to rent or buy chunks of land… often in places you wouldn’t otherwise want to be.
Once there, you pay the government for the proper permitting and licensing fees. You employ local people to keep them happy.
If you find something, the costs skyrocket. You have to rent or buy expensive drilling equipment. You pay engineers to write reports.
And after all this wrangling, less than one in 3,000 “discoveries” results in an economic deposit. Even then… if you actually find a big deposit… it can cost more than $1 billion to build a mine. And take more than a decade to complete. That’s a long time to wait for a return on your investment.
Thankfully, there’s a way to invest in these projects without all the risk.
Around 25 years ago, a few industry insiders came up with a safer model. Teaming with the best resource geologists in the industry, they evaluated as many ongoing exploration projects as they could find. And when they came across a top-shelf deposit, one likely to result in a profitable mine, they bought a stake in it, or a “royalty.”
Today, there are royalties on mines around the world. These royalties are usually paid to the original landowners… or to the first company to discover the deposit that eventually became the mine.
But some companies do nothing but acquire royalties on existing or developing mines… a business model that has worked extremely well for these companies and their shareholders.
Regular Growth Stock Wire readers are familiar with royalty companies.
Royalty companies don’t actually operate mines. Instead, they own a percentage of a mine’s production. Typically, a mining company sells a royalty to raise cash to build the mine. Once the mine is built, the royalty company gets a paycheck for the life of the mine.
It’s a winning proposition for everyone. For cash-starved miners, the upfront investment from royalty companies provides capital needed to complete the project.
And with its one-time payment, a royalty company reduces its long-term risk. It doesn’t have to waste time and money exploring barren territory. Instead, it can spread its risk across numerous projects… and hand-select the most promising. And once a mine is developed and the mining company begins repaying the investment, the income allows the royalty companies to add more and more coveted prospects to their portfolios.
These firms also have little overhead. Most employ a few experts – accountants, engineers, and geologists – to evaluate and buy new royalties. But other than that, there’s almost no cost of operation. There’s plenty of cash to grow the company… quickly.
That business model allows great royalty companies like Royal Gold (RGLD) and Franco-Nevada (FNV) to generate enormous profit margins of 80% to 90%… a heck of a lot better than the average mining stock. That’s why royalty companies have been among the great success stories of the stock market’s recent history.
For example, if you had bought Royal Gold back in 2004, you’d be sitting on 395% gains today… even with shares down 38% from their 2012 high.
The royalty business model has also allowed these companies to head higher this year – despite low gold prices. As you can see below, while GDX and Newmont Mining are both down double digits, Royal Gold shares are up more than 30%. And Franco-Nevada shares are up more than 16%.
In short, royalty companies allow investors to participate in the gold sector with far less risk and big upside potential. If gold prices stay low, these companies will fare better than gold producers because of their lower costs. And if gold prices recover, these companies will be some of the biggest beneficiaries.
If you’re looking to invest in the gold sector, consider Royal Gold and Franco-Nevada today.
Good investing,
Matt Badiali
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Source: Growth Stock Wire