April 13, 2024
Investment

Is This Unique Gold Investment the Perfect Inflation Hedge?


The global economy was thrown for a loop by the coronavirus pandemic, which resulted in countries effectively shutting businesses down to slow the spread of the virus. As the global economy opened back up, demand skyrocketed and supply chains couldn’t keep up. Given that backdrop, it shouldn’t be too surprising that inflation has been heading higher. Fear about inflation, meanwhile, often results in investors looking for investments that can provide inflation protection. Gold has been a beneficiary. But what’s the best way to add precious metals to your portfolio?

Investors are seeking safe harbors

There are no perfect investments. Everything comes with a trade-off. For example, safe income stocks often lack growth appeal. Or, in this case, buying a hard asset like a gold coin means you will only ever own that gold coin. But what does that gold bullion do for you? When inflation is raging gold prices often move higher because it is considered a store of wealth. Right now gold prices are near historical highs.

Gold Price in US Dollars Chart

Gold Price in US Dollars data by YCharts

Essentially, gold is one of the oldest forms of currency. And many investors believe that owning this precious metal is a way to protect against the decline in value of fiat currency. Fiat currency is backed only by the governments that issue it while gold is, well, a real physical item. There are a few ways you can add precious metals to your portfolio.

The first is to actually buy bullion (like gold coins). Transaction fees are high, you need to store it safely, and, as noted, a gold coin will only ever be a gold coin. You can, instead, buy a gold-backed exchange-traded fund. That helps to keep costs down and relieves you of the need to store it. But the gold in the fund won’t grow over time like a business could.

This is why many investors prefer owning precious metals miners. They sell gold and other metals, so their financial performance tends to track along with gold prices. But they can invest in their business and expand (by opening new mines, for example). While perhaps not the same as holding a gold coin in your hand, it is a balance between inflation protection and the growth potential that a gold coin lacks. But if that sounds good to you, then you should probably consider a fourth option — streaming and royalty companies.

Paying up front for low prices later

One of the big risks with a miner is that building and operating mines is expensive, complicated, and sometimes dangerous. When something goes wrong it can materially impact a miner’s financial performance. Streaming and royalty companies reduce the risks investors have to face. Companies like Royal Gold (RGLD 0.50%), Wheaton Precious Metals (WPM 0.63%), and Franco-Nevada (FNV 1.22%) don’t actually operate any mines, but they do have direct exposure to precious metals.

Essentially, streaming and royalty companies provide miners cash for the right to buy precious metals in the future at advantageous prices. The miners often use the money they get to build mines, though sometimes it can go to other things, like strengthening their balance sheets. This cash infusion means that the miner doesn’t have to issue shares or sell debt to raise capital. And often the gold and silver they promise to sell to Royal Gold, Wheaton, and Franco-Nevada is actually a byproduct of another metal they are mining, like copper. So it isn’t the main focus anyway. It is pretty close to a win/win deal.

What increases the attractiveness for investors here is that the upfront cash is all Royal Gold, Wheaton, and Franco-Nevada are expected to put in (other than the need to buy the precious metals at reduced rates in the future, but that effectively ensures they will make a profit on the transaction). If costs rise, that’s on the miner. The only real issue that will pass through to the streaming and royalty company is something that disrupts production, like a mine stoppage. Obviously the miner can’t sell gold to anyone if there’s no gold being produced. This is an issue for Franco-Nevada right now because one of its largest mines has stopped producing, leading to a deep downturn in the stock price relative to its peers. That could make it the best option for contrarian investors right now, but go in knowing that it could take a while for this situation to be resolved.

Gold Price in US Dollars Chart

Gold Price in US Dollars data by YCharts

There’s another important benefit. Because Royal Gold, Wheaton, and Franco-Nevada are, essentially, investing in precious metals mines, they tend to have fairly well diversified portfolios. A miner might have just a few operating assets but streaming and royalty companies usually have dozens of investments, some operating and some in an earlier stage of development. For example, Royal Gold’s portfolio contains 181 properties spread across 17 countries. That’s more diversification than you would get from any miner.

Meanwhile, all three of these stocks pay dividends. Royal Gold and Franco-Nevada focus on providing a growing stream of income. Wheaton, on the other hand, has a variable dividend policy that is driven by the company’s financial performance. So when precious metals prices are high investors will benefit more directly from the lofty commodity prices. That probably won’t interest conservative income investors, but it might be attractive to more active investors specifically looking to gold as an inflation hedge. Essentially, if precious metals prices rise along with inflation, the dividend from Wheaton might just be on the rise, too.

Don’t go all in on gold

Gold and silver are commodities and they can be volatile. It is probably best to view companies like Royal Gold, Wheaton, and Franco-Nevada as diversification tools, making up a modest amount of your portfolio (maybe 5% or so). And it is important to highlight that some on Wall Street question the actual inflation hedging benefit of gold and silver. But that just makes owning a streaming company, which can actually grow its business, all the more interesting as an alternative to bullion. Add in the reduced execution risk relative to a miner and Royal Gold, Wheaton, and Franco-Nevada start to look increasingly compelling for investors that want to add precious metals to their portfolio mix.



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