Beaver Creek: Wide disconnect between equities and commodity prices offers buying opportunity

The discrepancy between mining company valuations and commodity prices is at its worst levels in decades, the Precious Metals Summit in Colorado heard this week.

“This is probably the worst disconnect I’ve seen in over 20 years,” Haytham Hodaly, senior vice-president for corporate development for streaming pioneer Wheaton Precious Metals (TSX: WPM; NYSE: WPM), told the conference.

Eaun Gray, senior vice-president for business development at Franco-Nevada (TSX: FNV; NYSE: FNV) and a 30-year veteran of the sector agreed, calling the situation “unprecedented.”

“This is worse than the ‘little Bre-X thing’ when that came out and everything dropped,” Gray said.

Analysis by San Francisco-based Merk Investments, manager of the ASA Gold and Precious Metals (NYSE:ASA) fund, showed gold equities have been underperforming bullion for more than a decade and in April were near 2015 all-time lows. Toronto-based Sprott in July listed company share dilution, misallocation of funds, jurisdictional risk, low margins and longer permitting times as reasons for the discrepancy. 

However, the panel of royalty and streaming companies said the divide between mining equities and commodity prices is a buying opportunity for strategic investors.

Hodaly, who has nearly three decades of experience in the sector, said the industry’s approach during such periods of disruption is akin to “harvesting.”

“Royalty and streaming companies are essentially providing the necessary funding for other enterprises to advance their projects toward production. While this strategy may seem counterintuitive initially, it reflects a forward-looking approach to long-term value growth,” Hodaly said.

“We’re not seeing necessarily all the fruits of that yet, but I think over the next two to six, maybe even eight years, they will start to bring fruit.”

Wheaton is credited for creating the streaming model in 2004, helping to revolutionize the royalty business. Wheaton’s innovative approach to financing mining companies in exchange for a share of future production has become widely adopted and popular with investors. The model preserves companies’ capital structure while often enabling streaming companies to profit from any future project expansions at no cost.

Royalty companies, on the other hand, do not purchase future production. Instead, they receive a percentage of a mining project’s gross revenue or profit as a royalty payment. This royalty is typically based on a fixed rate of the mine’s production, regardless of the prevailing market prices.

M&A activity

Like the wider mining industry, royalty and streaming companies have seen strong mergers and acquisitions (M&A) activity recently — but with some differences.

Jason Hynes, vice-president for business development and strategy at Royal Gold (NASDAQ: RGLD), and John Griffith, chief development officer for Gold Royalty (NYSE: GROY), said M&A activity has evolved. Smaller royalty and streaming companies are consolidating with others in their league rather than being absorbed by larger corporations.

Royalty companies have advantages in the current market, such as scalability and the potential for upside, Gray and Griffith said. Unlike traditional mining investments, royalty investments offer a different risk-reward profile, which can be valuable to a diversified investment portfolio.

While royalty and streaming offer a lifeline to cash-strapped juniors, conversely, McEwen Mining‘s (TSX: MUX; NYSE: MUX) chief owner, Rob McEwen, criticized the role of royalty and streaming firms. They’ve taken advantage of mining companies in recent years, he said.