Several readers have recently sent in questions about a recent teaser ad from Big Gold, the “entry level” resource investing newsletter from Doug Casey’s newsletter stable … they’re pitching the idea of “Golden Tollbooths” that they think represent one of the best business models in the world, and though they hint around about a couple other companies they really focus on one.
Here’s how they get us interested:
“There is a special tollbooth located 8 hours north of Toronto near a gold mine. And every time a mining truck passes by, it must pay a toll: For each 100 ounces of gold carried, 4 of these must be paid to the tollbooth. Over $6,600. Every single time.
“What’s better, there’s another one of these ‘golden tollbooths’ located 20 miles east… and still another one 100 miles farther. All told, about seventy of these special tollbooths exist in the world today.
“And one company owns over half of them.
“Now this company – which has already banked $600 million on a single one of these tollbooth deals – is willing to split the profits with us…”
Ring a bell? Yes, sounds like he’s referring to some kind of royalty investment — which indeed he is, as the ad makes clear later on:
“Gold mining can be a very profitable endeavour – especially nowadays – but setting up a mine to extract the yellow stuff isn’t cheap.
“In fact, it can cost over a BILLION dollars just to build a mine and buy all the necessary equipment (not surprising, considering a single tire in the giant Cat 797 trucks used to carry gold can run north of $40,000)!
“That’s why, for most miners, borrowing money from a bank or giving up equity in their company often isn’t enough.
“They need to turn to golden tollbooth operators.
“In the gold industry, a tollbooth operator (or tollbooth company) is someone who helps fund a miner’s project in exchange for a cut – a toll – on all the gold produced at the mine in the future.
“These tolls vary quite a bit depending on the project, but typically range between 2% and 5% (with some extreme cases going all the way up to 75%).
“The great part about these tolls is that they stay attached to the mine in perpetuum – for as long as there’s gold to extract from the mine. That means that even if the mine gets sold, the original tollbooth company is still entitled to its tolls.”
So that’s the basic pitch — that royalties (“tolls”) are a better way to get leverage to gold. They don’t incur future costs if the mine gets more expensive to operate, they can grow as the mine grows, they can get you exposure to a rising gold price … I generally agree with that, and think that royalty-type companies are sort of a middle ground between risky individual mining stocks, which can give better leverage, and physical gold, which is not leveraged and can’t compound earnings or pay dividends.
Clark describes those key attributes of “tolls” as “kickers:”
“kicker #1 … the tolls levied by tollbooth operators often carry to acreage surrounding the mine, and not only to the mine itself.
“… this is important because rich gold deposits often occur in nature in clusters. In other words, if a miner discovers a significant gold resource, there’s a pretty good chance more gold will be found nearby.
“So naturally, even though tollbooth companies don’t depend on these extra discoveries to make money, they always try to include the most land they can in order to maximize profits down the line.
“And here’s kicker #2 for golden tollbooth investments: you get all the benefits of a rising gold market, but without any of the associated costs.
“Since tolls are simply a percentage of a mine’s gold output, an increase in the price of gold automatically translates into an increase in tollbooth profits.”
Gold mining and streaming deals are usually done with miners who are in the process of building (or planning to build) a mine, which means that they have to straddle a fine line — they have to spend enough money exploring to justify the cost of building the mine, but they don’t want to spend too much more until they’re actually producing gold, so they don’t fully drill and explore every corner of the potential mine before they start, they just make sure they have whatever amount of reserves is needed to make the mine “bankable” and give a high certainty of making a profit after the capital investment in the mine.
That’s an oversimplification, but I think it’s true in many cases — and it means that mines that are initially built with an expected life of eight years might keep producing for 20 years or more as they continue to do additional drilling to add to reserves as they mine.
So yes, royalties are delightful … but which one is Clark teasing here?
“… since I first told BIG GOLD readers in February 2011 about our favorite little-known tollbooth company, Canada’s Golden Tollbooth, it has provided a 95% return – nearly quadruple what GLD, the leading gold ETF, returned… and considerably better than what the HUI Gold Bugs Index returned, which actually decreased by 6% over this same time period (the HUI tracks a basket of leading gold producer stocks)….
“However, as great as these results have been so far, I believe it’s still small potatoes compared to what’s in store for the company over the next 2-3 years.”
And we get another story about one of the huge winners by the “Golden Tollbooth” company:
“Canada’s Golden Tollbooth is run by the man who first introduced the tollbooth model to the mining industry back in 1985. This man once turned an initial $2 million investment for a “tollbooth position” in a Nevada mine into $600 million of passive income. (In fact, that’s just what he’s made so far… when it’s all said and done he will have raked in over $1 billion on this one single tollbooth deal alone.)
“How did he make so much money?
“Well, just like in the fictional example we saw earlier, a mining company needed money to build a mine. In this case, they had found 500,000 ounces of gold buried in the ground.
“Or so they thought…
“Lo and behold, a couple years later an additional 50 million ounces of gold were discovered on the property (100 times more than the original estimate)! Well, since this tollbooth operator had negotiated a royalty deal for acreage all around the mine, and not just the mine itself (golden kicker #1, if you remember), he was able to profit on every single one of these additional 50,000,000 ounces… all without ever putting up another single investment dollar…
“… one of the projects Canada’s Golden Tollbooth has a toll on recently made one of these discoveries – an additional one million ounces of gold they weren’t banking on. And still another project they’re involved with north of the border is in an area with ideal geology (with an estimated 14.9 MILLION ounces of gold in the ground already identified)… so don’t be surprised if more gold is found there too….
“A Gold and Silver “Tollbooth Twist”
“This deal is hot off the press… and features a slight twist on the typical tollbooth play. In this case, Canada’s Golden Tollbooth will help pay for a mine in Central America for the right to buy gold and silver later on at greatly reduced prices ($400/oz. for gold and $6/oz. for silver). Given current precious metal prices, this will likely end up being a massive coup. In fact, a back-of-the-envelope calculation shows the company should make about $110 million annually in the first 11 years alone… and they’ll be collecting for at least 31 years starting in late 2015.”
Any other clues? Sure …
“… a single share in Canada’s Golden Tollbooth sells for about $50… 95% gains since last year …
…Canada’s Golden Tollbooth has deals on 25 projects in development right now, with revenues yet to kick in that could exceed $2 BILLION… and that’s without an extra 139 exploration assets they have on hand that will surely yield a few more discoveries in the future.”
Enough? Yes, the Thinkolator’s been ready to chew on this one for a while … and you will be unsurprised to hear that this is North America’s royalty giant, Franco-Nevada (FNV in both NY and Toronto).
Franco-Nevada was a pioneer of the gold royalties business in the 1980s, then was subsumed within Newmont for about five years in the mid-2000s, and then IPO’d again and has been on a tear as a public company since 2007 (other than the expected dip in 2008 and 2009). They have some diversification with a few energy and base metal royalties, but are focused on gold just like their US cousin, Royal Gold (RGLD), which is a bit smaller and a bit better-known among US investors. The two companies have similar valuations, trading for about 30X next year’s expected earnings, and they’re both very lean, with only 10-20 employees despite their large market capitalizations (RGLD is a $5 billion company, FNV about $8 billion).
I don’t own shares of either of these large royalty firms, though longtime Gumshoe readers know that one of my largest personal holdings is in Sandstorm Gold (SAND), an “up and coming” competitor in the mine financing space, and I love the model… and I have had a limit buy order in for Franco-Nevada warrants for a while, it probably won’t trigger but if the price dips and I get to buy some, I’ll take ’em. Sandstorm Gold is mostly a streaming company, meaning they provide funding up front and then make deals to buy a share of future production at a set price — as opposed to straight net smelter return royalties, which are usually for a much smaller portion of the gold (or silver, or whatever) and don’t require any per-ounce payments. The streaming model was pioneered by Silver Wheaton (SLW), which is the largest “passive” company of this type if you include silver as well as gold “tollbooths”, but RGLD and FNV also do some streaming deals in addition to their many royalty deals.
The other clues match FNV perfectly as well, including that “twist” of a streaming deal that was hinted at in Central America — that’s the biggest royalty/streaming deal I’ve ever heard of, with Franco-Nevada putting up a BILLION dollars in exchange for a complex set of streaming deals on gold and silver from the huge Panamanian Cobre mine, you can see the details here if you like. They also do have a royalty on the massive Detour mine in Ontario that was hinted at in the clues.
Analysts see FNV getting a nice earnings bump, in part from relatively new projects like the Detour mine, in this year, so the shares are trading for about 30 times expected 2013 earnings. The risk of huge losses and the anticipation of gains depends in large part on what you think will happen to gold prices — if gold collapses below $1,000 and mines start shutting down, then royalties on those mines aren’t worth so much. If gold goes to $3,000-5,0000 fairly soon as Jeff Clark expects (not necessarily this year — he says “it’s not a question of if, just when,”) then Franco-Nevada is going to have cash raining down upon them like you wouldn’t believe.
I do think that most portfolios can benefit from some gold exposure, and I hate trying to pick winners among gold stocks (I’m bad at it, and gold mining is a nasty and surprising business), so I keep my gold equity exposure in these kinds of streaming and royalty stocks — currently I’m invested in Sandstorm Gold because I like their management and their long-term growth potential, but I wouldn’t argue with anyone who wanted to hold FNV or RGLD for their “tollbooth” exposure. Franco-Nevada has done slightly better than Royal Gold over the past year, but over the long term the two have tended to track pretty closely together, with blips for specific deals or surprises, so I wouldn’t overthink it — if you like gold, then any of the big royalty companies are a relatively diversified, nicely leveraged play on gold.
Full disclosure: I do own shares and warrants of Sandstorm Gold, and continue to have a buy order in for Franco-Nevada warrants just in case I get lucky. Other than that order, I won’t trade in shares of any of the stocks mentioned above for at least three days.
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