Gold Exposure: Why a Royalty Company Offers a Better Moat Than a Producer

The macro backdrop for gold has been exceptionally strong. Over the past year, the metal has delivered a return of over 60%, capping an "exceptional 2025" with a surge to record highs. This rally has been driven by a potent mix of factors: persistent geopolitical uncertainty, aggressive central bank buying, and growing expectations for interest rate cuts. For a producer like Newmont, the world's largest gold miner, this environment is a direct tailwind. Its revenue and earnings are fundamentally tied to the price of gold, meaning it stands to benefit from this historic move.

Yet, for a value investor, the producer's setup presents a structural dilemma. Newmont's profitability is a function of two variables: the price of gold and its own operational costs. As the evidence shows, the company's gross profit margin was 34.6% and EBIT margin was 26.7% in the latest year. While these are solid numbers, they are not immune to the pressures that come with scaling production. Inflation, for instance, can drive up the costs of labor, energy, and equipment-expenses that directly squeeze margins. The company's own financials reveal the volatility inherent in this model, with net income swinging from a loss of $2.5 billion in 2023 to a profit of $3.3 billion in 2024. This kind of earnings choppiness is a classic feature of commodity producers.

This is where the royalty model offers a clearer moat. Companies that own royalties on gold production are not direct producers. Their business is structured to be largely immune to the inflation-driven cost pressures that buffet miners. The evidence is stark: Since the pandemic lows, gold royalty companies have offered an impressive 33% return, significantly outperforming both gold itself and gold mining stocks. More telling is how they have held up during inflationary stress, while mining company returns fell. For an investor focused on compounding over long cycles, the ability to deliver more stable returns with less operational friction is a compelling advantage. The producer wins when gold rises, but the royalty holder often wins when the path is bumpy.

Analyzing the Business Models: Moats and Volatility

The core difference between a producer and a royalty company is one of economic structure, and thus, the width of their moats. For a value investor, the producer's model is inherently more capital-intensive and operationally complex. It requires massive upfront investment to develop and maintain mines, faces relentless pressure from rising input costs for labor and energy, and is subject to the vagaries of operational execution. This creates a narrower moat, one that can be eroded by inflation or poor management. The volatility in Newmont's net income-from a loss of $2.5 billion to a profit of $3.3 billion in just two years-illustrates this earnings choppiness. The company's fate is tied to both the price of gold and its own cost curve, making its cash flows less predictable.

By contrast, the royalty model offers a wider, more durable moat. A royalty company's revenue is a fixed percentage of a producer's output, typically paid in cash or gold. This structure insulates it from the inflation-driven cost pressures that squeeze miners. As the evidence shows, royalty companies have remained immune thanks to their unique structure, offering stronger returns when mining profits fall. Their business is largely a matter of contract and portfolio management, not of digging in the ground. This results in far lower operational risk and capital intensity. The company's cash flows are more predictable, derived from the physical production of mines rather than the volatile arithmetic of gold price minus costs.

This structural difference is what makes royalty cash flows more stable and treats market volatility as noise. While gold mining company returns fell downwards during the inflationary surge of 2021, royalty returns held strong. Even in a period when gold itself fell, royalty companies managed a positive 1.7% return while mining stocks dropped sharply. The dividend picture reinforces this stability. Mining company payouts are highly volatile, subject to large cuts when gold prices fall. Royalty companies, by design, seek to provide growing stability with their dividend payouts, adjusting them to ensure consistent shareholder rewards. For an investor focused on compounding over decades, this predictability is a powerful advantage. It means the business can be valued more like a steady cash-generating asset, rather than a high-risk commodity bet.

Valuation and the Case for a Better Value Proposition

For a value investor, the ultimate test is not just a strong business model, but one that offers a superior risk-adjusted return and durable intrinsic value. When we compare the producer and the royalty, the valuation story becomes clear. The producer's stock price is a direct leveraged bet on the sustainability of the current high gold price. Its intrinsic value is tied to a volatile equation: gold price minus operational costs. This makes its valuation highly sensitive to any shift in the macro environment or a slowdown in the producer's own cost control. In contrast, the royalty company's valuation is anchored to a more stable cash flow stream, derived from a portfolio of existing mine production. This structural difference provides a better risk-adjusted return profile over the long cycle.

The evidence on returns tells the story. Since the pandemic lows, gold royalty companies have offered an impressive 33% return, far outperforming both gold and gold mining stocks. More importantly, this outperformance has been most pronounced during periods of stress, like the inflationary surge of 2021, when mining company returns fell while royalty returns held strong. This resilience is the hallmark of a wider moat. It means the royalty's cash flows are less likely to be disrupted by the operational and cost pressures that buffet producers. For an investor, this translates into a more predictable stream of returns, which is the foundation of compounding.

Looking ahead, the outlook for gold remains bullish, with forecasts pointing to prices potentially reaching $5,000 per ounce by the end of 2026. This is a powerful tailwind for both models. Yet, the royalty's advantage is not in the magnitude of the rally, but in its ability to capture it with less risk. Its lower operational risk and higher cash flow predictability represent a more durable competitive advantage. The producer's model is a high-stakes game of timing the price and managing costs. The royalty's model is a steady, contract-based income stream that compounds through cycles. For the patient investor, the choice is not between two good options, but between a volatile commodity bet and a more stable, cash-generating asset. The data suggests the latter offers a better value proposition over the long term.

Catalysts, Risks, and What to Watch

The thesis for the royalty model rests on its structural advantage: a wider moat that translates to more stable compounding. The forward view hinges on a few key catalysts and risks that will validate or challenge this setup.

The primary catalyst for gold, and thus for both models, is sustained central bank demand and geopolitical uncertainty. The evidence shows central bank and investor demand for gold is set to remain strong, averaging 585 tonnes a quarter in 2026. This persistent, non-speculative buying provides a fundamental floor for prices. For the producer, this is a direct leveraged benefit, as higher prices flow through to revenue. For the royalty, it is a more indirect tailwind, but one that supports the health of the underlying mines whose production generates the royalty stream. The broader macro backdrop-heightened geopolitical and economic uncertainty and a weaker dollar-also favors gold, creating a supportive environment for both.

The key risk for the producer is a sharp decline in gold prices. Such a drop would compress margins already under pressure from operational costs, threatening earnings and potentially leading to dividend cuts. The volatility in Newmont's net income-from a loss of $2.5 billion to a profit of $3.3 billion-illustrates this vulnerability. For the royalty investor, the watchpoint is different. The risk is not the price of gold itself, but the health and production of the specific mining assets that underpin the royalty portfolio. If a mine faces operational setbacks, cost overruns, or is forced to cut production, the royalty cash flow could be disrupted. This is a more granular, asset-specific risk compared to the broad commodity price risk faced by producers.

Looking ahead, the outlook for gold remains bullish, with forecasts pointing to prices potentially reaching $5,000 per ounce by the end of 2026. This is a powerful tailwind for both models. Yet, the royalty's advantage is not in the magnitude of the rally, but in its ability to capture it with less operational friction. The investor's job is to monitor two things: the macro drivers that support gold's long-term trend, and the operational performance of the mines that feed the royalty stream. For a value investor, the royalty model offers a more predictable path to compounding, but it requires a different kind of diligence-one focused on the durability of the underlying contracts and the mines, not just the price of the metal.