Why Gold Bulls Have Sights Set on Franco Nevada

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One of the most popular investments among gold bulls is Franco Nevada Gold (NYSE:FNV). Franco Nevada is a royalty company, meaning that it provides capital to mining companies in exchange for the right to some of the gold these companies produce in the future. The deals are designed to be mutually beneficial. Mining companies get the capital it needs in order to explore for gold or develop mines, and Franco Nevada gets revenue that is leveraged to the gold price.

Royalty companies have inherent advantages over mining companies as investments. First, royalty income is directly correlated to the gold price — if the gold price rises, Franco Nevada’s income will rise, and if the gold price falls, then Franco Nevada’s income will fall as well. Mining companies have profits that are related to the gold price, but these profits also depend on the cost of producing the gold. So for instance, suppose the gold price rises from $1,000/ounce to $2,000/ounce. We can say unequivocally that Franco Nevada’s revenue will rise, and assuming its production remains constant, its profits should roughly double. But a mining company may see a different outcome. If, for instance, the mining company’s cost of production rises with the gold price from say $500/ounce to $1,500/ounce, then the mining company will not benefit from the higher gold price; its gross income will remain at $500/ounce.

Second, Franco Nevada and other royalty companies don’t have to spend any money on exploration, but it reaps the benefits of successful exploration. If Franco Nevada owns a royalty on a mine, and the company who owns the mine discovers more gold, unless otherwise stipulated the mining company still has to pay a royalty on any new gold discovered and subsequently produced. Meanwhile, that mining company has to do the following:

  • Pay for drilling
  • Develop a resource estimate
  • Develop a mine plan
  • Apply for and retain permits
  • Construct the mine

While the mining company is paying for all of this, companies such as Franco Nevada just sit back and wait for the money to roll in.

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