The impact of inflation on the gold industry

The gold industry has been affected by the inflationary spiral of the last two years. However, the impact has been very different depending on the type of company. The profit margins of mining companies have been greatly reduced, while the royalty companies that finance them have hardly been affected.

The profits of mining companies, with high overhead costs, have been severely eroded by the massive increase in energy and fuel prices. Royalty companies, on the other hand, which provide financing or land to mining companies in exchange for a percentage of revenue or production, have been boosted.

Since the beginning of 2021, gold has appreciated by less than 20%. Although this is a significant percentage, it is much lower than that experienced by energy and fuels over the same period. For example, electricity has risen by 20-30%; coal has doubled in price and at many points even quadrupled or quintupled in price; and oil has risen by around 50%, with peaks between March and June last year more than doubling the cost in early 2021. To this must be added significant wage increases around the world.

The burden of structure

Given that mining operations require large amounts of machinery, energy and personnel, it is not surprising that the net profit margins of the major gold mining companies have fallen considerably over the past two years.

Data from the world’s two largest mining companies illustrate this. After reaching a net margin of more than 36% in the second quarter of 2020, the balance sheets of the giant Newmont Goldcorp have progressively worsened to negative results in the last two quarters. In the same period, Barrick Gold’s net profit margin has fallen from 39% to less than 4%.

Royalty and streaming companies

The performance of royalty companies, which typically include both royalty and streaming companies, has been very different. These usually finance the activities of mining companies through what would be equivalent in Spain to a participation account contract, which is a hybrid between a loan and a shareholding. This financing formula is often more attractive for mining companies than traditional debt or capital increase. 

Royalty agreements provide borrowers with a percentage of the mining company’s sales over the life of a deposit. Although there are many formulas for arrangements, the most common one fixes royalties on the basis of the smelter’s net return or, in other words, gross revenues. The particularity of streaming agreements is that the consideration for the initial funding is not financial, but directly a share of the mine’s gold production.

Two factors have meant that royalty companies have hardly been affected by inflation and have maintained huge profit margins. On the one hand, because most royalty agreements calculate royalties as a percentage of the mine’s gross revenues rather than its profits, their turnover has remained relatively high in the last two years. On the other hand, because they have minimal overheads, their overheads have hardly increased.

Minimal structure

Unlike mining companies, which have huge workforces and have to maintain large facilities with fleets of vehicles and heavy machinery, the royalty companies’ structure only includes a few offices with a few dozen employees, including mining engineers, geologists, metallurgical technicians and financiers. 

This has allowed Franco-Nevada and Wheaton Precious Metals, the world’s largest royalty companies, to maintain net profit margins above 50% in all their quarterly reports since mid-2021 despite high inflation. 

Protecting savings with physical gold has been one of 11Onze’s main contributions to its community, and now the range of products is expanding. This is why, in the face of volatility, still high inflation and the growing crisis of confidence in the banking system, gold is once again strengthening its position as a safe-haven asset. Discover Gold Seed at Preciosos 11Onze.