by Travis Johnson, Stock Gumshoe | August 27, 2009 10:04 am
This ad has been floating to the top of my inbox for a couple days now, and since the people have spoken I thought I better write about it right quick for you — I am, after all, your humble sleuthing servant. Well, OK, maybe not so humble all the time, but do you want to know about these investments or not?
The ad is for a newsletter whose picks I often find interesting, Extreme Value from Dan Ferris. Here’s how he opens his pitch:
“‘Gold-Backed Annuity’ Shares
“Only 3 of these unique investments exist in the entire world.
“These shares entitle you to a “lifetime” stake in gold mining revenues, which have a history of paying as much as 32,000% over an 18 year period…”
The letter starts by mentioning the boring nature of real annuities — where you invest a lump sum with an insurance company, and they pay you out some sort of guaranteed return for a set number of years, or for the rest of your life, depending on the contract.
And Ferris tells us that these investments he’s teasing us about are sort of similar …
“In short, the way these investments work is simple:
“A group of investors form a company to receive guaranteed “annuity” payments based on gold revenue from many of the world’s most profitable mines. These groups allow you to take an equity stake in their company.
“In other words: You are buying shares in gold companies that function just like annuities.
Like ordinary annuities these “Gold-Backed Annuity” companies require you to make an initial investment.
“But that is where the similarities end…
“You see, instead of trickling out miniscule returns of 7% a year, “Gold-Backed Annuity” companies have a track record of absolutely enormous gains…
“In fact, the Canadian “annuity” investment I’m going to tell you about could have returned an astonishing 32,000% over an 18 year period… meaning an initial investment of just $5,000 could have paid you $1.6 million!
“And while the stock market got crushed last year, one of these American ‘annuity’ companies based in Denver returned an incredible 65% to equity holders. (Over the past decade, this same “annuity” company has returned a whopping 744%.)”
Well, that’s really all we need to give you the answer for these — but for those of you playing along at home, let’s take a quick look at the specific clues for what Ferris calls the “#1 Retirement Investment in America.”
“Gold-Backed Annuity Company #1
“This company is based in Toronto, Canada.
“They have over 300 ‘annuity’ contracts with various mining operations all over the world.
“These gold ‘annuities’ give the firm revenue rights on mines in Nevada, Mexico, California, Indonesia, Canada and Australia.
“On one of the gold mines in Nevada, this firm has been getting guaranteed ‘annuity’ payments for 20 years. And will continue to get payments for the life of the mine, which is expected to be another 9 years.
“In fact, in 2008, this one ‘annuity’ brought the company and its shareholders $49.7 million, based on their contract to receive 4% of the lifetime profits.
“Another ‘gold-backed annuity’ contract on a mine in north-central Nevada has paid the firm $250 million, thanks to a 7.29% contract on all profits.
“They also have a 5.1% ‘annuity’ contract on another mine in Nevada, which paid them $13.4 million last year.
“And on a Montana mine, they have already received $17 million from ‘annuity’ payments. They believe the mine should be good for “annuity” payments of $12 million a year for the next 50 years.”
This one, dear friends, is Franco-Nevada, and their biggest “annuity” is the royalty stream they purchased from the Goldstrike mine run by Barrick (that’s the $49.7 million in 2008 revenues).
Franco-Nevada is the granddaddy of the big mining royalty companies, though it has fairly recently recast itself as a gold-focused royalty firm and they own a lot of royalties on other natural resource projects, including oil, gas and other precious and base metal mines. It trades at FNV in Toronto, and at FNNVF on the pink sheets (very low volume).
So I should explain what these “annuities” are, no? This and the other two companies, which we’ll explain in a moment, are royalty companies — they put up cash to finance exploration and development of known mines or mineral deposits, and in exchange they receive a lifetime royalty on the production from that mine (or oil well, or whatever). For the large Goldstrike mine, for example, Franco-Nevada invested many, many years ago in helping Barrick exploit this mine, and in exchange they have a number of different royalties on different sections of the mine, ranging from 1% to 6% of the net gold produced (the “net smelter return,” one of the more common ways of calculating royalties) and, in total, bringing in that near-$50 million total last year.
These royalties can be of a few different types, and the agreements can be entered into at any time — you can get a better royalty return (a bigger chunk of the production for your dollar) if you invest in an exploratory property, but you also take the chance that the mine won’t be successful; and you can buy royalties in a proven and producing mine, but of course those royalties will be more expensive to reflect the known value of the future revenue stream.
So that’s the good part — the royalty investors invest cash up front, and they own, usually forever, their share of that mine’s product. They are not generally obligated to ever invest any more in the mine, or to pay for capital costs or maintenance of the mine, so if the mine keeps producing for 40 years they keep that revenue flowing for a long time with no additional outlay, which can make for a very nice high-margin business once the royalties you invested in start producing.
But, there’s also a bad part — investing in a royalty stream is also a way of taking some of the risk away from the miner, they get the cash to build the mine, but they don’t guarantee that there’s going to be a particular return on that cash. If the mine turns out to be a dud, or production is closed for a couple years due to a flood or an earthquake or whatever, they aren’t producing so they don’t have to pay any royalties. And of course, this is an upfront investment that the royalty company has to make, and in calculating their expected return from that investment they have to make assumptions about commodity prices at the time that they begin to receive their royalties — if they’re wrong, and gold is $500 an ounce when that mine starts producing but they assumed $1,000 an ounce, they might take a long time to get any return at all out of that investment, and there are royalty investments that turn out to be nonproducing duds that never provide royalty income. That’s just the nature of natural resources investing.
So that’s the added value that professional royalty investors can bring to the table, and probably why there aren’t that many of these companies (though there is also plenty of private royalty investment, between companies and by institutions and wealthy individuals). Franco-Nevada was the first big one, at least in this era, and it has also been teased heavily in the past by other newsletters who called this idea the Chaffee Royalty Program … back then they teased Franco-Nevada as an investment that was “closed” for a number of years and only recently reopened, that was because it was bought by Newmont in 2002 and got spun off again as a public company in 2007.
When you’re looking at royalty companies you generally want to see a firm that has a broad and wide portfolio — lots of different investments in different mines that all produce royalty income, as well as a “bench” of investments in exploratory projects that may pay off big in the decades to come, that’s how you can get to a portfolio that provides pretty stable cash flow, so these big royalty companies that have large portfolios are generally not home-run hitters who will double off of a big strike at one of their royalty properties, for those kind of quick gains you need a junior miner who gets smart or lucky (or, of course, a really rapid change in the commodity price).
When you look at Franco-Nevada these days the story is largely about gold, and they’ve said that gold mines will be their focus going forward, but do note that they own a lot of other royalties, too. Back in the Summer of 2008 when energy prices were insane, they got about half of their revenue from oil and gas and the other half from gold (that’s an exaggeration — there are small slivers of base metal and precious metals in there, too, but those were the big drivers). Now, with gold still performing well and oil lower, and the company refocused specifically on gold, the gold royalties provided about 75% of Franco-Nevada’s revenue in the second quarter of this year.
And, though Franco-Nevada does have a big portfolio of projects, it’s worth noting that the Goldstrike mine makes up a huge portion of their revenue right now — they got something like $150 million in royalties last year, and almost a third of that was from Goldstrike, so that’s the one property that could potentially significantly upset their revenue by itself if they happen to have any problems. I doubt they will, it’s a huge, productive, and well-studied mine, but you never know.
Just to make clear, it does make some intuitive sense to call these “annuity” companies, since the firms themselves to put up an initial cash outlay for the promise of potential regular returns in the future, but while the term may help to explain the concept we should never make the mistake of confusing “royalties” with “annuities” — royalties are a share of what is produced, annuities are a contract to pay you some kind of regular guaranteed return. There’s precious little that’s guaranteed about royalties, since a lot can happen to change the production level and some projects will never be profitably mined … and since all three of the companies teased here do pay a small dividend we can say that there’s a potential for lifetime income, but the dividend is tiny for all three at this point, and it is, of course, also not guaranteed in any way.
So … got some of that small print out of the way … we’re talking about royalty companies that invest in mines for a share of future production, and Ferris teases two others. What are they?
“Gold-Backed Annuity Company #2
This company is based in Denver, CO. They own 118 ‘annuities’ on some of the world’s most attractive gold mines…
“In places such as Mexico, Nevada and West Africa.
“In 2008 they received total “annuity” payments of $69.4 million.
“They got $7.4 million from a West African mine where they receive 15% of the profits.
“Best of all, the mines in which the company owns ‘annuities’ have reserves of approximately 64 million ounces of gold.
“And with gold priced at well over $900 an ounce, that’s over $57 billion dollars in ‘annuity’ payments the company is entitled to in the near future. ”
That one is Royal Gold (RGLD) — and they are also a favorite of several other newsletters, including some of the other Stansberry editors. This one has been specifically focused on gold for more of its life, but it’s significantly smaller and does still have some non-gold legacy investments, too.
There’s nothing much more to say about RGLD — I’ve written about it many times, and I owned shares until very recently and still like it (I sold for personal reasons, nothing to do with the prospects for these shares, and I may well buy back in a few months).
Like Franco-Nevada, Royal Gold pays a pittance as a dividend (roughly 1% for each of them), and has a nice, high-margin business that tries to recycle their royalty payments into new investments that will keep the revenue flowing far into the future. They also have a pretty big portfolio of producing and exploratory investments, some of them on the biggest potential new mines around, like the producing Penasquito mine in Mexico or Osisko’s Malartic property in Quebec (that mine has been heavily teased lately, too, but won’t start producing for a couple years).
And there was one more stock teased here — royalty watchers will know it, because there are precious few of these companies around, but let’s have a look anyway:
“Gold-Backed Annuity Company #3
“The first two ‘gold-backed annuity’ companies I described are great investment, to be sure.
“But they’ve been around for more than 20 years. And the days of 1,000% gains, I’m afraid, are probably long gone.
“You see, what I haven’t yet explained is the fact that to make the most money possible from these unique investments, you simply must get in early.
“And the good news is: There is now another chance for you to make absolutely astonishing gains thanks to a relatively new and unknown ‘Gold-Backed Annuity’ company…
“What very few investors know is that in 2003, a small group of investors with a ton of experience in the gold and mining business got together.
“They were led by a 28-year industry veteran… who locked up “annuity” payments on mines in the U.S., Canada, Chile, Spain, Australia and South Africa, to name just a few.
“They have a total of 85 ‘annuity’ contracts on these various mines.
“This includes a huge Canadian mine where they receive 2.7% of the profits for life, and made $9.6 million in 2008. This mine is expected to produce for another 25 years… until 2034.”
This one is International Royalty Corp (ROY in NY, IRC in Toronto).
And this is the baby on the block — they have been around only since 2003, but they do also pay a dividend of about 1%. The big difference with ROY is that it’s a lot smaller (they have four or five producing properties, one of which absolutely dominates their numbers right now), and it’s not particularly focused on gold.
ROY’s big asset is their 2.7% NSR (Net Smelter Return) royalty on the Voisey’s Bay mine operated by Vale — this is a massive nickel, copper and cobalt mine, and it makes up far more than half of ROY’s revenue right now and for the foreseeable near future. One reason that ROY’s shares took much more of a hit than RGLD or FNV last year was this reliance on Voisey’s Bay — ROY is much more of a nickel and copper play than it is a gold play, and their revenues from that mine fell by almost half from the second quarter of 2008 to the second quarter of 2009.
They do have some gold in their future — they get relatively much smaller royalties from a couple young producing gold mines right now, and they do have a number of other investments in their portfolio, but if you look over their holdings you can quickly get a handle on exactly what they own because the portfolio is so small. It’s nearly impossible to get a grasp on RGLD or FNV’s portfolios in an hour of browsing.
ROY is also the one that, because of its relatively small size and youth, has had a less balanced balance sheet of late, which probably also hurt the share price — but they raised some money with share sales this year and seem to be in much more solid shape and without a frightening debt load at the moment. ROY trades at about 1X book value, RGLD trades at about twice book value, just to give you an idea of how investors are valuing the two companies — and ROY also gets about half of the forward PE ratio of RGLD, so clearly the base metals and the small size make folks more nervous about International Royalty.
But who cares about someone else’s nerves — what do you think? It is, after all, your money. Would you (or do you) invest in any of these, even if you think it’s silly to call them “annuities?” Prefer the somewhat under-the-radar commodity play of ROY, or the more targeted and mature gold royalties from RGLD or Franco-Nevada, or is there something else you like in this space? Let us know with a comment below.
And Dan’s Extreme Value newsletter is one that we don’t have a lot of reader reviews on, so if you’ve ever subscribed please click here to submit a review and let us know what you thought.
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