The Precious Metals R&S Index Declined by 5.9 Percent in May, as Gold Itself Lost Only 2.6 Percent

A gold royalty is a contract that gives the owner (a gold royalty company) the right to a percentage of gold production or revenue in exchange for an upfront payment. Gold royalty companies use these contracts as a way to finance mining companies in need of capital. Some investors were seeking exposure to the corresponding index, alleging that royalties were less volatile than the underlying metals. The present research note clearly disproves this notion.

Royalties on precious metals and streaming companies are a very attractive sub-industry of the precious metals mining industry they represent. They provide some leverage for increasing metal prices similar to what investors often seek in their typical mining companies portfolios substituting corresponding underlying commodities, but they are less risky, because their revenues are generated through royalties and streaming arrangements. Under a metal streaming agreement, the streaming company provides an initial payment to purchase the right to future deliveries of a predetermined percentage of metal production of a mining operation.

The streaming company also pays some ongoing payments that are usually well below the market price of the metal. They can be set as a fixed sum (e.g., $300/oz gold) or as a percentage (e.g., 20% of the prevailing gold price), or a combination of both (e.g., the lowest between [$300/oz gold] and [20% of the prevailing gold price]). The royalties usually apply to a small fraction of the mining project production (normally not larger than 1-3%), and they are not subjects to ongoing payments. They can have various forms, but the most common is a small percentage of the net smelter return ("NSR"). The NSR is calculated as revenues from the sale of the mined products minus applicable overheads, i.e. transportation and refining costs.

Interestingly, some major changes occurred in April 2021. Due to the boom of the royalty and streaming industry and the emergence of many new mining companies seeking to play on Chinese economy reopening, the indices experienced two major changes. Firstly, the market capitalization-weighted index was modified to include only the 5 biggest companies: Franco-Nevada (FNV), Wheaton Precious Metals (WPM), Royal Gold (RGLD), Osisko Gold Royalties (OR), and Sandstorm Gold (SAND). The combined weight of these 5 companies on the old index was around 95%. The values of the index were re-calculated back to January 2019, and between January 2019 and March 2021, the difference in the overall performance of the old and the new index was only 2.29 percentage points. The second change was related to the equally weighted index that was expanded to 20 companies.