A Royal Play for Gold Investors

09/19/2013 7:00 am EST


Adrian Day

Chairman and CEO, Adrian Day Asset Management


We are recommending a former holding that we previously held for three and a half years; it is a gold royalty company, which is one of our favorite types of companies, notes Adrian Day, editor of The Global Analyst.

Royal Gold (RGLD) provided us with a gain of 181%. In truth, the stock was a little ahead of itself in the general exuberance surrounding gold stocks.

However, it has since come down to earth, both with the broad gold stock decline, and also, concern over some of the properties on which it holds royalties.

Many of these genuine problems are being resolved, and the price decline is overdone. This is the time and the price to buy Royal Gold.

Royal has a great pipeline of projects, some of which are problematic and which have caused the market's concern. But the large Canadian Mt. Milligan property—in which Royal purchased an attractive streaming deal in three tranches.

Again, this was part of the concern about Royal, perceived as putting good money after bad as Thompson Creek struggled with Milligan, amid a sharp drop in the molybdenum price (and one reason we sold when we did).

But the mine is on schedule to start producing by the end of the year, and it should generate revenue for Royal of over $100 million a year (that's over $1.50 per share) at today's price.

At $1,500 gold, this will generate over $140 million a year. Once that cash flow hits the revenue line, the market should respond very well.

Another large project on which Royal holds a royalty with problems is Barrick's Pascua Lama mine. It is worth emphasizing that despite the huge capex increases, and lawsuits on both sides of the Argentina-Chile border, Royal does not have to bear increased costs.

Rather, it is faced with a likely one-year delay in the mine coming on line (and therefore receipt of its royalty). At worst, Barrick would abandon Pascua and Royal Gold would have a write-off on its $400 million investment.

But it is not, and will not be, responsible for the massive cost overruns, or fighting lawsuits, or any other additional costs and burdens.

Even today, with its flagship Penasquito mine in Mexico running below expectations, and before Mt. Milligan, Royal is generating over $300 million in royalty revenue. With nearly $700 million in cash, it is well-financed. This alone makes Royal a good value.

Move ahead to 2015, with Mt. Milligan in full production, and Royal selling at a significant discount, even if there is no progress at any of its other large-scale future royalties (in addition to Pascua, there is a newly acquired royalty on Goldcorp's stalled El Morro mine).

Take this opportunity to buy Royal Gold up to $56. We will be putting it in the mid-risk portion of our investment pyramid. It is appropriate, however, even for conservative investors looking for a gold holding.

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