During commodity bull runs, mining companies are exposed to inflationary cost pressures, capital cost overruns, equity dilution and misguided merger and acquisition (M&A) activity as bullish managements strives to expand near-term production to take advantage of high commodity prices.
Bearing this in mind, an alternative way to gain exposure to commodity prices – while being largely insulated from the issues associated with direct equity ownership – is through royalty streams. Royalties typically earn a percentage of turnover from the production of commodities, providing direct exposure to commodity prices without direct exposure to operating and other expenses, and so have a lower risk profile than mining equities. Royalty companies have historically outperformed mining equities, too.
Importantly, capital and exploration expenditures by operators often benefit a royalty holder by extending the life of mines, boosting production rates and progressing development assets towards production without cost to the royalty holder. Producing royalties also tends to deliver strong cash returns, which can be leveraged through relatively lower-cost debt and underpin dividends to shareholders of royalty companies.