Gold could be poised for another record-setting year. This obscure part of the market may see big gains

Published Fri, Jan 26 20241:00 PM ESTUpdated Mon, Feb 12 20241:29 PM EST

Investors betting on another strong year for gold may want to look at an obscure part of the market: gold streaming and royalty companies. At their core, gold royalty and streaming companies offer miners and investors an alternative form of financing instead of investing directly into a mine itself. These companies structure deals in which a cash payment is given in return for either a cut of future mining revenues — a royalty contract, or future production — a streaming contract. Betting on these names can help investors ride another potentially strong year, while providing them with a hedge against potential declines. Gold prices climbed 13.2% in 2023 and reached an all-time high above $2,100 per ounce. "If I took our entire mining coverage universe — everyone from Newmont , Barrick Gold , Agnico Eagle , down to the small guys — over the long term, the royalty companies have outperformed by a long shot," Canaccord Genuity analyst Carey MacRury said to CNBC. Since 2008, Franco-Nevada and Royal Gold are up more than 600% and over 250%, respectively. The VanEck Gold Miners ETF (GDX) , meanwhile, is down more than 30% in that time. Pros and cons of gold royalty and streaming stocks For investors, these royalty and streaming contracts have a distinct benefit over investing in a traditional mine because of their cost-hedging abilities. Royalty and streaming companies have almost zero associated costs — other than their small staffs — versus the costs in equipment, electricity, gas and labor incurred by a mine. Gold royalty and streaming companies sprung up because "the costs of a lot of these mines were going up even more, so they weren't getting the benefit of the rising gold price because they were giving it all back in terms of cost," Adam Rozencwajg, managing partner at investment firm Goehring & Rozencwajg, told CNBC. "The profitability of the gold companies wasn't keeping pace with the rise in the gold price." Through a royalty or streaming deal, investors can thus extract as much value as possible from a possible rise in gold prices. These contracts also offer investors diversification and free exposure to exploration since they're diversified across different mines and regions, making them a good choice for more generalist investors who don't want to worry about the technical details of mining, according to Canaccord's MacRury. And because gold streaming and royalty companies don't have to deal with the production costs of building new mines, they can grow at a much quicker rate than a traditional mining company. However, there are some drawbacks. While gold royalty and streaming stocks have outperformed their mining peers, they also tend to trade more expensive due to their hedge against cost inflation. As a value investor, however, Rozencwajg has found it hard to pay their often-steep premium. "We can never really make the justification for doing it. And I'll be perfectly honest, it's always been a mistake," he said. "Every year we look at them like gosh, they're really expensive. The mining companies are cheaper. And it feels like every year, year in and year out, the streamers in the world do better than the mining companies." For example, U.S.-listed shares of royalty company Royal Gold trade at 33 times forward earnings, per FactSet. Meanwhile, mining company Barrick Gold trades at 19 times forward earnings. Gold positioned to rally in 2024 That said, gold could see another strong year, especially if the Federal Reserve cuts rates in 2024. This would in turn boost streaming and royalty stocks. Rozencwajg said gold's strong performance last year was counterintuitive. That's because as interest rates rise, investors generally sell their gold holdings in favor of other higher-yielding assets. But Rozencwajg attributed last year's gain to an uptick in gold demand from global central banks, particularly the ones in nations such as Brazil, Russia, China and India. MacRury also noted that investor optimism may have also played a role in lifting prices of the precious metal in 2023. "In our view, the gold price performed well (despite volatility) on increasing market expectations that the Fed was nearing the end of its hiking cycle and ultimately discounting rate cuts starting in 2024," he wrote in a recent report. @GC.1 1Y mountain Gold in past year But slightly lower rate cut expectations have softened gold prices to start off 2024, with the commodity already pulling back 2.3% year to date. Despite this near-term blip, the outlook remains bright for the precious metal. "Every time real interest rates have gone down, the Western investor has switched from being a gold seller to being a gold buyer," Leigh Goehring, the other half of Goehring & Rozencwajg, said to CNBC. MacRury echoed this sentiment, pointing to historical context as a reason he believes gold prices could hurtle towards new highs. "Past easing cycles over the last 20+ years have corresponded with strong gold prices, and we expect to see gold set new record highs in 2024," he wrote. What stocks to buy MacRury's coverage universe includes seven royalty and streaming stocks, with the three biggest players consisting of Franco-Nevada, Wheaton Precious Metals and Royal Gold. The analyst has a buy rating on all names besides Franco-Nevada, which he rates as hold due to losses tied to the closure of a key Panama mine. MacRury's current top pick in the royalty and streaming space is Wheaton. The analyst cited the company's solid growth profile and balance sheet, compelling valuation, expanding projects and its exposure to silver as strong catalysts. "We continue to view WPM as having one of the highest-quality portfolios of streams underpinned by long-life, low-cost assets operated by major mining companies, with strong growth ahead (+25% by 2025)," he wrote. Wheaton's U.S.-listed stock rallied 26% in 2023, and is up just 1.4% for the past 12 months. Catalysts for Royal Gold include the firm's available liquidity of around $770 million, as well as its 23 consecutive years of dividend increases, MacRury wrote. "Our BUY recommendation is based on Royal Gold's high-quality portfolio, strong balance sheet and attractive valuation versus its royalty/streaming peers," he added. His target price of $146, recently updated from $143, means that Royal Gold stock could rally 25.8% from its Thursday closing price of $116.07. Shares of Royal Gold popped 7% in 2023, but are down more than 10% in the past 12 months. RGLD 1Y mountain RGLD 1-year chart The analyst also likes Osisko Gold Royalties , which provides "a compelling combination of growth, asset quality and value," he wrote. He added: "The company has a number of royalties on other projects advancing through the development pipeline with potential catalysts over the next 12-18 months."Mantos Blancos Phase 2, and Corvette." Osisko's U.S.-listed stock rose 18% in 2023.