3 Reasons Royal Gold, Inc. Stock Could Fall

By Markets Fool.com

The Pueblo Viejo Mine. Image source: Barrick Gold.

Continue Reading Below

Royal Gold, Inc. (NASDAQ: RGLD) is a streaming company, which means it does things a little differently when it comes to the precious metals market. However, it's subject to some of the same risks as miners and to some that are a bit different. Here are three reasons Royal Gold's stock could fall.

1. Partner troubles

To understand this first risk, you need to understand what Royal Gold does. Precious metals miners look for, dig up, and sell gold and silver. There are numerous issues along that path that can create problems. Royal Gold, on the other hand, gives miners cash in return for the right to buy gold and silver from operating mines at reduced rates in the future. It doesn't get its hands dirty, so to speak.

So, if a miner faces rising costs for labor or supplies it would make less money from the mine. Royal Gold wouldn't care; it would still pay the same amount. It's why miners like Barrick Gold (NYSE: ABX) work so hard to keep costs in check. Barrick, for example, is looking to get its all-in sustaining costs for gold down to $750 an ounce this year from $864 in 2014. Barrick's profit margin is directly impacted by its costs, while Royal Gold is insulated from such day-to-day issues. But it still has to worry.

Royal Gold's key mines. Image source: Royal Gold.

Continue Reading Below

For example, if there were a labor issue or a mine disaster that stopped production, then no gold or silver is being produced. And, in turn, there's nothing for Royal Gold to buy. If a key mine were to shut down, Royal Gold investors would likely get nervous and sell. Note that a single mine made up over 20% of revenue in fiscal 2015. There's also the risk that an investment in a mine under construction doesn't bear fruit, which would likely be viewed negatively by the market, too.

Royal Gold is a way to invest in gold without investing in a mining company, but it doesn't remove all the risk of mining.

2. Commodities

The next risk that could lead to a stock price decline is at first pretty obvious: gold and silver price volatility. But rising and falling precious metals prices can be both a positive and a negative at the same time.

For example, Royal Gold's top- and bottom-lines are clearly reliant on gold and silver prices. If commodity prices go up, it makes more money. If commodity prices fall, it makes less.But falling commodity prices can lead to miners seeking out financing alternatives beyond the equity and bond markets and banks. That's where Royal Gold comes in, since it's kind of like a specialty finance company that gets paid in gold and silver.

To give you an idea of what this means, in 2015, during the depths of the gold and silver downturn, Royal Gold was able to increase its reserves by just over 20% through a series of streaming deals with cash-strapped miners -- like the $610 million deal it inked with Barrick and its Pueblo Viejo Mine.

That's good for the company because it means there's more gold and silver to sell when prices go up. In the quarter ending in June, the end of the company's fiscal year, Royal Gold's volume of gold equivalent ounces sold increased 21% year over year, with gold prices up 6%. That helped push revenue up 28% and earnings per share up 38%.

Some of Royal Gold's mines. Image source: Royal Gold.

But higher gold and silver prices can also lead to less opportunity to invest in streaming deals. And that could slow future growth. When gold and silver prices are high, miners have more financing options and can avoid streaming companies or at least drive a harder bargain. If Royal Gold's growth slows, it could lead investors to shun the stock. Higher commodity prices, then, aren't all good.

3. Access to capital

The third big risk that you need to watch for at Royal Gold is access to the capital markets. The basic model for streaming companies is to sell shares to the public and use that cash to pay for streaming deals. Selling stock, then, is an integral piece of Royal Gold's growth story.

Although Royal Gold isn't having problems with access to the capital markets today, if it ever did, its growth engine could stall. A streaming company with a stagnant growth profile would probably be viewed in a negative light by investors.

Add to this the fact that Royal Gold's mine investments are inherently limited by the amount of gold and silver that can be profitably recovered. So no new investments would likely mean a slowly declining production profile, too. A double whammy that would surely result in stock price declines.

An odd duck

Royal Gold is a very different way to invest in precious metals. Because of the way it invests in the space, you need to think about the company in a slightly different way. For example, mining costs don't matter all that much but work stoppages matter a lot. And gold and silver price moves can be good and bad at the same time, regardless of the direction you're talking about. Then there's the not so subtle issue of being able to sell stock to fund streaming investments. That's not to say that you should avoid Royal Gold -- it's a well-run company. But you do need to understand the nuances of the streaming business it runs.

A secret billion-dollar stock opportunity
The world's biggest tech company forgot to show you something, but a few Wall Street analysts and the Fool didn't miss a beat: There's a small company that's powering their brand-new gadgets and the coming revolution in technology. And we think its stock price has nearly unlimited room to run for early in-the-know investors! To be one of them, just click here.

Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.