Arbitrage & Precious Metal Royalty Companies
Most royalty or streaming valuations rely on multiples. The gross income multiple is the most widely used multiple in royalty valuation. Sometimes analysts will go further and calculate the present value of a stream. These methods of valuation are great tools, but they cannot entirely grasp the streaming business model.
A gold stream involves an upfront cash payment in exchange for the right to purchase a percentage of a mine’s annual gold production at a fixed price per ounce. Notice a stream has the same characteristics as a call option. The fixed price per ounce is the strike price, and the upfront payment is the option premium. A 10-year stream is just 10 European call options, with one option expiring each year for 10 years. A stream is actually just a set of European call options.
If a stream is just a call option, then it follows that option pricing can be used to value a single stream or an entire streaming company. Sophisticated option pricing methods are controversial, but there are non-arbitrage option pricing constraints that are indisputable and universally accepted. These constraints are valid because arbitrage opportunities arise if a constraint is violated. Here is the fundamental constraint concerning streams: The minimum price for a European call option (stream) is the spot price, minus the present value of the strike price.
For example, suppose spot gold is $1,500 and the interest rate is 5%. A one-year, $400 strike call option on gold has a minimum price of $1,120. The present value of the $400 strike is $380. The spot gold price ($1,500) minus the present value of the strike ($380) equals the lower bound ($1,120). This same process can be used to value a stream.
Consider Sandstorm Gold’s (SNDXF.PK) Aurizona project, which allows Sandstorm to purchase gold at $400 an ounce. The table shows the results of using the option pricing rule above to evaluate Aurizona:
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