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Buffett
has always said that you should find a company that has pricing power that
can offer protection in an inflationary environment. What he means with this
is you should find companies which can pass higher costs on to its customers.
He once said that the ideal asset in an inflationary environment is a royalty
on someone else's sales.
If
inflation is 3%, so if prices rise 3% per year, and you get a check based on
the sales, your income goes up 3% a year without doing anything.
Now
this is really interesting. Not that we are in an inflationary period right
now (at least that is what the statistics in Fantasy land are saying), but
gold prices are inflating. So the gold mining companies are in a favorable
business right now. What about the Gold royalty companies? I personally think
they are in an even better situation. Why? Because the costs for mining gold
has increased dramatically over the years, as the easy gold has been mined,
causing companies to dig deeper, which costs loads of money.
Basically,
Royalty companies pay capital to a company which doesn't have the means to
expand. In return for this capital, the royalty company gets a percentage of
the sales. Note that the rising costs don't affect the royalty company's
results, as they get a % of SALES, and not PROFITS! So even if costs go up,
bringing profits down for the mining companies, royalties can still increase
if production and thus sales increase!
Let's
have a look at some royalty companies:
1)
Randgold: Isn't this a nice trend? (Please notice that RandGold (Ticker:
GOLD) went higher in recent weeks, despite markets going down)
 
Chart courtesy stockcharts.com
Chart courtesy stockcharts.com
2)
Franco Nevada (Ticker: FNV.TO)
Chart courtesy stockcharts.com
3)
Royal Gold (Ticker: RGLD)
Chart courtesy stockcharts.com
4)
Silver Wheaton
Chart courtesy stockcharts.com
Now
let's have a look at the HUI index, an index composed of several mining
companies:
Chart courtesy stockcharts.com
It
just kept up with gold, rising 6 fold since 2002. Not bad, but wouldn't you
prefer the Royalty companies after you have seen these charts? Historical
results are no indication of future performance, but I think the trend is
clear.
Another
Royalty company is Tanzanian Royalty Exploration. Its President is no one
less than mr. Jim Sinclair.
Mr.
Sinclair proclaimed in the 70′s that gold (then trading around $150 per
ounce) would hit $900. It eventually peaked at $887.50 and mr. Sinclair sold
his position the following day. He declared the Bull Market dead for the next
2 decades, despite some analysts predicting gold could go as high as $2,000.
Boy, was he right. He made a new prediction in the early 2000′s that
gold would hit $1,650 by January 14th 2011. It hit this level on August 2nd,
so mr. Sinclair was, once again, not far off.
Let's
have a look at the chart:
Chart courtesy stockcharts.com
Measured
in gold, this stock is trading at the lows of 2008 and 2009 and it is on a
long term support line. It also seems to be retesting the breakout above the
red resistance line right now. One of Jesse Livermore's trading rules was:
"Be right & Sit Tight".
Chart courtesy stockcharts.com
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