A Low Risk Way to Play a Bottom in Gold
We haven't talked about gold lately for one simple reason: investor interest in the precious metal dissolved along with its price. And with most gold mining stocks still beaten down, the majority of investors seem content to remain on the sidelines.
But gold looks to have bottomed in mid-summer at around $1,200 per ounce. That level marks a 37% decline from its 2011 high of $1,900.
The bottom for gold is apparently now in place. Now the question is how to play it.
My advice is to steer clear of the mining ETFs. They carry exposure to too many companies still suffering from overextension during the boom. Just look at Barrick ( ABX ), a holding of The Market Vectors Gold Miners ETF ( GDX ), as a prime example of what you don't want exposure to.
Barrick is one of the biggest companies in the industry with a market cap of $18 billion. It just announced a $3 billion equity raise to "strengthen its balance sheet and improve its long-term liquidity." That news, announced last Friday, drove shares down another 7.5%. The stock is off 60% over the past two years.
I don't want to own a basket of stocks that could include many "Barricks." I'd rather own a targeted investment that represents the single best way to gain exposure to gold's stabilization and potential recovery.
A far better option is a gold streaming and royalty company such as Franco-Nevada Gold ( FNV ). This business model is a winner, especially in this environment, since Franco-Nevada avoids various risks associated with developing and operating gold mines. Yet investors still get exposure to the upside of commodity price, reserve and production increases.
In exchange for an initial investment, which helps a miner fund exploration or mine development, Franco-Nevada receives the rights to a portion of future gold production. This royalty is usually around 2% of the extracted gold.
Royalty companies like Franco-Nevada are not subject to cash calls to fund exploration, development or mine closures. And they do provide operational or mine development management, so a large and diversified portfolio can be assembled without the need for significant corporate overhead. For example, Franco-Nevada owns a royalty interest in more than 300 different projects.
The hard work is deciding which projects to buy into, negotiating the terms and figuring out how much to pay. Franco-Nevada has a proven history of doing this well, and I believe the current environment offers up several new opportunities.
Hundreds of junior gold miners are sitting on too few dollars to stay in business. With their share prices obliterated, they can't even tap the equity markets to raise cash. Franco-Nevada can sweep in and buy up assets at fire-sale prices.
Its latest royalty purchase was a 2.5% royalty on Kirkland Lake Gold's (KGI.TO) properties in exchange for $50 million. Kirkland Gold owns some of the best gold properties in Ontario, but the company's share price has been slashed by 80% over the past two years. With little cash and a depressed equity value, one of Kirkland's few options was to bring in a partner like Franco-Nevada.
As a final point I should mention that over the past two years, shares of Franco-Nevada are actually up, by 15%. That's incredible performance in the face of an imploding industry. And I believe it highlights the fact that the gold royalty and streaming business offers investors exposure to gold's strength, without the associated downside risk that an individual miner might face.
I recommended Franco-Nevada to subscribers of my Top Stock Insights advisory service in July. We're up around 15% since then and I still rate Franco-Nevada as a "buy." Given the low-risk business model, I think Franco is a good way for gold investors to get some exposure to the precious metal today.