Gold, Royalty Trusts, and high levels of debt

In my last post I asked about why gold miners aren’t moving up with gold prices.  One obvious answer would be hedging because mining is a very different business than commodity investing.  As I mentioned prior, RGLD purchases royalty trusts in gold, acquiring a share of the gold sales from different mines around the world.  The counterpart to the trade would be a gold miner interesting in reducing it’s exposure to gold – just like any longtime producers of all commodities reduce their risks to ensure they can stay afloat and continue to earn cash from operations in the event of a price drop.

Royalty trusts in energy have been sold directly on the market for quite some time and offer unique investments.  They start out as basic mineral rights to an area with an approximate measure of how much they’ll be able to produce – which can increase or decrease as the quantity of reserves is better known or as technology increases the amount that can be recovered.  Royalty trusts are not companies and do not operate the wells or mines, they are simply mineral rights that dry out as the resources in the area are exhausted.  Typically they will have low yields at first, which increase as production ramps up, go on as steady cash cows for years (usually starting with 20+ years of production estimated, and heavily affected by the underlying commodity price of course), and then both the dividend payments and ticker price fall as production wanes in the aging mines or wells.  There is a list of royalty trusts that trade directly from ticker symbols here:

You will note that the list has no royalty trusts in gold, and I have not yet found any royalty trusts that are linked to gold.  RGLD is the closest I’ve seen, but they are actually a company which purchases royalty trusts and has a low 0.7% dividend because they are actively increasing their holdings.  Their dividend will likely increase in future years, provided that gold remains strong, when they are ready to slow down their acquisitions.  This is a unique play and I tend to like the idea.

This article shows some interesting comparisons of the miners, and I particularly liked this chart:


This shows a number of gold miners in comparison and you can see that not all of them are profitable (as a negative profit margin means a negative profit).

Grant Williams also had some interesting comments on gold here:

Grant notes that the miners tend to be crowded with hot money rather than long term investors and tend to be volatile, but believes that they offer good opportunities if you believe that the current gold prices will last.  He also mentions that at a mining conference in Melbourne, Australia there was a presentation by Nick Holland, the CEO of Gold Fields Ltd about what would really start to attract the attention of long term investors, such as providing higher dividend yields and much more careful risk management in new projects.  As time goes on in this low rate world, pension funds could look at yields of 3% or more from the miners as compared to the 2% yield of the S&P 500 and decide they might be a good place to park some money as both a dividend payer and hedge against market uncertainty and inflation.  Interest from the big players would certainly create a significant bump in the prices and bring more stability to the sector.


On a separate note, John Mauldin has been writing about large enough debt becoming an economic singularity which completely changes the underlying drivers of economics much as a black hole changes the driving forces in physics.  Just like Newton’s laws of physics will no longer predict motion inside an event horizon, the economic models predicting growth patterns from stimulus vs austerity, or taxes vs government spending, tend to break down as high debt becomes more of an issue.  Other factors become much more important in trying to escape the slowing affect of debt, so that one answer simply cannot suit all countries or all economies.  Stimulus in the face of high debt tends to have a much lower temporary positive affect for example, and doesn’t necessarily reinforce into a growth cycle.

I tend to believe that stimulus spending can help us significantly if it is in income producing assets which have high and positive net present value (such as an oil pipeline in an area with sufficient demand), but that positive NPV investments are nearly impossible politically for the government to do.  Even if positive NPV investments are possible for governments, like the significant government-led capacity expansion in things like cement and steel production in China, they can easily be overdone leading to an oversupply situation.  We are certainly in the face of a unique cycle as the level of globalization is unprecedented and the government debt problems are facing many of the largest economies at once – particularly in Europe, Japan, and the United States.

On a political note, people make too much of the potential affects of the US presidential election on the markets, but I tend to believe that both the free-spending Obama or Romney’s sparking of possible trade and currency wars with China and other countries (all that “currency manipulator” talk) will tend to be a positive for gold in the years to come.

I hope this provides some food for thought,

John Taylor


About johnonstocks

I've been trading stocks since 2003, active on Motley Fool's discussion boards and using first Hidden Gems, then Global Gains. I no longer have the newsletters, but I keep up on the WSJ and read David Rosenberg everyday at Education: CFA level 2 candidate MBA-focus in Finance, Marshall, University of Southern California - expected Dec 2010. BS Mechanical Engineering, UC San Diego, June 2002
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