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Hidden Investment Gems, As In Royalty Stocks

09/15/11 08:38:27 AM
by Billy Williams

The best investments are typically the ones that no one hears about until it's too late -- royalty stocks may be that kind of investment today.

Security:   RGLD, FNV
Position:   Buy

In the global market, there is a vast selection of investments that include everything from equities, debt, currencies, hard commodities, soft commodities, metals, energy, agricultural, and more, but some of the best investments are typically the ones you don't hear about. Warren Buffett, for example, made a fortune between 1957 to 1969 on investments that exploited opportunities in mergers and the effective use of arbitrage. In fact, during that same time, half the total returns on Berkshire Hathaway were the result of those investments apart from the returns gained through value investing, the investment style most synonymous with Buffett.

Most investors get mired in the individual investment dogma associated with a particular method versus actually finding where the opportunities lie while wearing blinders to the possibilities that exist outside their narrow view. Ironically, using your own approach can be extremely fruitful as long as you're willing to expand your horizons and look outside your narrow view of investment choices. See Figure 1.

FIGURE 1: RGLD. Royal Gold is a gold royalty stock that has been a very strong performer in the resource-driven bull market whose trend should gain the attention of any smart speculator.
Graphic provided by:
This is important because the markets are becoming an ever-greater violent tempest as Europe teeters at the tipping point of another banking crisis and the US economy on the other end of the scale teeters on a second recession that almost all economists declare as inevitable.

Despite the gloomy prospects at the moment, this should serve as both a warning and a signal to expand your sights and look where the opportunities are.

First, look to where the strongest trends are. At the head of the line is gold and precious metals, which have been moving at a steady clip to the upside for several years, and with all the uncertainty in the market, it appears that this move will continue. With the US government unable to do much about the oncoming debt crisis and out-of-control spending, it appears that they can do little except for printing money.

As a result, investors who wish to preserve the value of their cash holdings are accumulating gold bullion in order to preserve their wealth. See Figure 2.

FIGURE 2: FNV. With the rest of the stock market struggling under the severe decline, Franco Nevada, a gold royalty company, is showing extreme strength in a diffcult market and moving upward at a steady clip.
Graphic provided by:
However, bullion isn't always practical for small investors, and for large investors, it can prove difficult and risky to store as well.

Like investing, in gold, it can be prudent to diversify your holdings and spread your exposure to control risk. One of the overlooked stock investments is the royalty company. These companies are typically cash-rich and invest in companies that mine or produce resources that are in high demand under the condition they can buy their resources at a fixed price so they can turn around and resell them.

As a hypothetical example, Royalty Co., ABC, approaches Oil Drilling Co., XYZ, and agrees to finance XYZ's oil development project under the condition that ABC can buy XYZ's oil for $50 a barrel, which they can turn around and sell on open market for its current price of $85 a barrel.

XYZ gets its financing and can develop its oil field and gain more revenue for its company, while ABC gains a $35 profit on any oil it resells in exchange for its investment.

Now, this is a good deal for Royalty Co., which then turns around and distributes its profits back to its investors through steady dividends. However, if oil declines below $50, this becomes a losing deal for the royalty company and typically is reflected in a declining share value.

With gold in a steady uptrend, it might be a good idea to consider investing in stocks that have exposure to gold but also distinct competitive advantages such as the license to buy gold at a cheap price for a quick gain on the difference from the current trading value of gold. The benefit is that as gold continues to trend upward, it is likely that gold royalty stocks will receive steady dividends, which throw off a strong yield on your investment by themselves.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

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