A Profitable Investment, Even During Record Inflation

Investors are increasingly worried about inflation... and for good reason.

Just look at the cost of two key consumer goods across the country...

The average price of gas is now about $3.42 per gallon – $1.25 more than in 2020 and 82 cents more than in 2019. And according to the Manheim Used Vehicle Value Index, used-car prices have also soared. This index has now reached an all-time high, marking a 38% increase from a year ago.

On Friday, the University of Michigan released its monthly survey of consumers, which showed that consumer sentiment has fallen to a 10-year low. And there's one common theme among respondents – their concern about rising inflation.

Additionally, the U.S. Bureau of Labor Statistics ("BLS") recently released two of its inflation gauges – Producer Price Index ("PPI") and Consumer Price Index ("CPI"). The PPI measures the average price of goods used in manufacturing and production, while the CPI measures the average price of goods and services for consumers.

And both metrics surged in October...

The PPI rose 8.6% from the same month in 2020, tying the highest level since the BLS began tracking this data in 2010. And the CPI rose 6.2% from October 2020, marking the highest CPI reading in more than 30 years.

Ongoing supply shortages and bottlenecks, along with high consumer demand and the Federal Reserve's extremely accommodative monetary policy, mean that this trend will continue into 2022.

This recent data is fueling investors' inflation fears... And it has sent them rushing for inflation protection through gold. In fact, after the BLS' CPI release, gold jumped to its highest level since June.

The reason for that is simple: Inflation weakens the U.S. dollar. High inflation means that it will cost more to buy an ounce of gold. But the gold supply is relatively scarce, so it can retain its purchasing power. That's why investors usually head for precious metals to hedge against inflation.

Today, we're sharing one of our favorite ways to profit from higher gold prices... We're talking about royalty and streaming companies.

They don't sell gold, like miners and explorers. Instead, these companies provide upfront capital to mine operators. In return, the royalty companies receive a percentage of sales (the royalty) or the right to purchase metals at a predetermined cost (called a "stream"). The takeaway here is that they collect revenue based on a mine's production – not its profitability.

These royalty companies also avoid the consistently high costs of exploration and production. That makes them an extremely capital-efficient way to play higher gold prices. As a result, they remain profitable even if precious metals prices fall.

Franco-Nevada (NYSE: FNV) is a titan of the gold-royalty industry. In fact, it pioneered the precious metals-royalty business.

Franco-Nevada has a portfolio of 406 assets all around the world. Of these, 324 are mineral assets, including gold and silver royalties. Of those, 58 are precious metals interests in production, which generate a steady cash flow for Franco-Nevada's coffers. Another 42 precious metals interests are on track to become producing mines. Franco-Nevada also holds royalties on 82 energy projects in its portfolio.

The company's portfolio includes royalties on some of the most famous mines on Earth, including Goldstrike, Stillwater, Detour Lake, and Kirkland Lake in the U.S. and Canada, Guadalupe-Palmarejo in Mexico, and Candelaria in Chile.

Let's take the Goldstrike mine in Nevada as an example. In 2019, two of the largest gold miners in the world – Barrick Gold (GOLD) and Newmont (NEM) – created a joint venture for the mine. Barrick has a 61.5% stake, and Newmont controls the rest.

Franco-Nevada holds a net smelter return ("NSR") royalty of 2% to 4% on Barrick's production from the Goldstrike mine. That means it gets 2% to 4% of the net revenue that Barrick receives from the sale of the mine's metal products.

Franco-Nevada also holds a net profit interest of 2.4% to 6% for the majority of the mineral reserves on the Goldstrike property. That means it receives the above percentage of net profits – the amount which remains after deducting all operating, interest, and tax expenses.

In 2020, its Goldstrike agreements led to about $21 million in revenue for Franco-Nevada. The company expects similar production levels this year. Recent third-quarter results show that revenue is up 36%, compared with the same period a year ago.

This is the strength of the royalty model. After helping Barrick set up and operate the Goldstrike mine, Franco-Nevada can now collect a percentage of any net revenue coming from Barrick's share of the production for years to come.

But this company doesn't just rest on its laurels... Franco-Nevada is always looking to establish new royalties in various commodities, as good opportunities arise. As of September, the company had more than $300 million in cash on its balance sheet, with zero debt. So, it's well positioned to make new acquisitions and finance mine expansions.

Best of all, Franco-Nevada doesn't need higher gold prices to thrive. Of course, it earns more in royalty payments when the price of gold is high. But because of its capital-efficient business model, money continues to flow in even when prices slip, as long as miners continue to produce gold.

And with this strong business model, Franco-Nevada generates enough cash flow to handsomely reward shareholders. The company has increased dividends for 15 consecutive years. In fact, Franco-Nevada paid out $197 million in dividends in 2020. And, so far in 2021, it has paid out another $164 million.

Royalty and streaming companies like Franco-Nevada enjoy all the upside of a bull market in gold in an extremely capital-efficient way. They don't have to deal with the usual costs associated with exploring for gold or building and operating an actual mine. It's a far superior business model to exploration and production... And Franco-Nevada is one of the best.

Sometimes investing is simple.