Everyone needs an emergency plan whether that is in real life or in an investment portfolio. Income investors are not exempt from this concept, and actually they are the one investor class that needs to be the most careful in these times. Typically, most income investor share common traits and desires. The vast majority want steady and reliable cash inflows, coupled with capital preservation. Unfortunately lurking in the financial markets there are some very real threats and outright dangers for the income investor.
By simply turning on your television or reading your paper, you will see a whole host of potential threats. Risks such as war in the Middle East, sagging economies, and banking issues splash their way across the media for all to see. But sometimes the biggest monsters out there get ignored and lost in all the noise. That is until someone of importance speaks up and shines the light right on the issue. This is exactly what Bill Gross (Founder and Managing Director of PIMCO) recently did in his latest investment outlook post. In it he wrote the following:
It will not be if we continue down the current road and don't address our "fiscal gap." IF we continue to close our eyes to existing 8% of GDP deficits, which when including Social Security, Medicaid and Medicare liabilities compose an average estimated 11% annual "fiscal gap," then we will begin to resemble Greece before the turn of the next decade. Unless we begin to close this gap, then the inevitable result will be that our debt/GDP ratio will continue to rise, the Fed would print money to pay for the deficiency, inflation would follow and the dollar would inevitably decline. Bonds would be burned to a crisp and stocks would certainly be singed; only gold and real assets would thrive within the Ring of Fire.
As complex as the issue is, what it basically boils down to is that the U.S. has $16 trillion of outstanding debt and no idea how to address it. That is a huge number, but waiting behind that is the future liabilities that are wrapped up in such well known programs as Social Security, Medicare and Medicaid. Add those figures into the debt and we get a number that is completely off the charts. Neither political party truly has any idea of how to tackle this big a monster, so it basically is ignored.
Let's go back and revisit something that Mr. Gross stated. Remember the following statement:
…the Fed would print money to pay for the deficiency, inflation would follow and the dollar would inevitably decline. Bonds would be burned to a crisp and stocks would certainly be singed; only gold and real assets would thrive within the Ring of Fire.
For our financial well being, Mr. Gross gives us the answer to what should do well (gold and real assets). The question becomes how do we apply this to an income portfolio? Let's start with the gold idea. When investing in gold or precious minerals, people usually do not relate it to an income investment. Since this is a survival guide for an income investor let's see if we can tailor that into the mix.
The Gabelli Global Gold, Natural Resources & Income Trust (GGN)
One name that will be of particular interest to income investors will be GGN. GGN is a non-diversified, closed-end management investment company with $1.3 billion in total net assets whose primary investment objective is to provide a high level of current income. The fund is not an investment in physical gold or natural resources as the name might suggest. The fund makes investments in equity securities of firms operating in the gold and natural resources industries. To earn income the fund uses a strategy of writing (selling) primarily covered call options on equity securities in its portfolio.
The fund currently makes monthly distributions and its yield is around 9.8%. While not a direct play on physical gold, this fund and the companies that make up its holdings should do well as gold soars and the U.S. dollar drops. It would not be like having direct exposure to the physical asset, but it would probably be one of the best income producing assets with gold exposure.
Other real assets that usually go along with gold is the energy sector. Lately this might not have been the case as we have seen natural gas prices at historically low levels, and oil prices continue to be volatile. That being the case, the income survival plan should still point to some exposure in companies that operate in this sector.
Here once again I am going to suggest one of my favorite energy holdings, LINE. LINE is an independent company that engages in the acquisition and development of oil and gas properties. The company's properties are primarily located in the Mid-Continent, the Permian Basin, Michigan, California, and the Williston Basin in the U.S. Linn is a top-10 U.S. independent oil and natural gas company. The company focuses on the development and acquisition of long-life properties that complement its asset profile.
There are a lot of energy companies out there, and they are not all equal. Several of them were taken by surprise by the volatility in energy prices. As a result several well-known companies suffered through large drops in their share prices. LINE was not one of these companies, and the reason for that is its hedging program. LINE is approximately 100% hedged on expected natural gas production for six years through 2017. The expected oil production is 100% hedged for five years through 2016. For 2012, the company is hedged at a weighted average oil price of $97.26 per Bbl and a weighted average natural gas price of $5.28 per Mcf.
Linn's reserve-life index is approximately 18 years. Since its IPO in 2006, the company has grown its cash distributions more than 80%. At the time of this writing, LINE is paying a quarterly dividend rate of 7%. LINE is definitely a name that should be in part of a survival holding.
If investing in MLPs like LINE is just too much of a tax headache, then recent happenings surrounding this company might be to your liking. Linn Energy just launched LinnCo, LLC (LNCO). LinnCo will have no assets or operations other than those related to its ownership of LINN units.
A closer look at LNCO shows that each share represents one common unit of Linn. The company as a whole will own 13.2% of Linn. The thought behind such a deal was to structure LinnCo as a corporation in the hopes to attract institutional investors and pension funds that are often unable to buy into partnerships. A very cunning move by LINE, and that is one reason why it should make the cut into the portfolio.
CVR Partners, LP (UAN)
When investors think of real assets their attention immediately turns to gold and oil. Obviously this theme is followed here in this article as our first selections fell into those sectors. Another sector that should do well is the agriculture side of the house. One focus could be on corn and the bull market it has based upon the shortages created by this year's terrible drought. The question is how to capitalize on this for an income portfolio? The answer very well might be UAN.
UAN is a partnership formed by CVR Energy (CVI) to own, operate and grow the nitrogen fertilizer business. The nitrogen fertilizer manufacturing facility is located in Coffeyville, Kan. It is the only such operation in North America that uses a petroleum coke gasification process to make hydrogen, a key ingredient in its manufacturing process, and produces about 5% of the total UAN demand in the United States. Currently the company is generating distributions of around 8.9%.
While many sectors of the economy suffer, UAN is booking some rather impressive numbers. For the first six months of 2012, the net income of UAN was $65.3 million on net sales of $159.7 million compared with $54.9 million of net income on net sales of $138.1 million for the comparable period a year earlier. The average realized plant gate prices for ammonia and urea ammonium nitrate were $568 per ton and $329 per ton, respectively, compared with $574 per ton and $300 per ton, respectively, for the same period in 2011. Needless to say, these are some solid numbers.
When looking at 2013 and beyond, UAN is anticipating a continuing positive fertilizer pricing environment as a result of growing demand for corn and the effects of the severe drought conditions on this year's crop. UAN's management also feels that it made important progress on its expansion project during the 2012 second quarter, and that is expected to benefit from a full year of increased production in 2013. The company has estimated that the expansion could contribute 50 cents per common unit of cash available for distribution versus 2012.
UAN is a stock that would probably fair better than most under Bill Gross' vision of needing to own real assets. Their petroleum coke gasification process should help it somewhat hedge against future volatility in energy prices. Regardless of inflation issues, UAN's products are needed and vital to crop production. A holding within a defensive portfolio could be considered.
In conclusion, trying to find income investments that fit into Bill Gross' vision is not easy. Above are three names that might fit the bill, but obviously more research needs to be done before one buys in. I feel that Mr. Gross is right on point and his warnings should not go unheeded by investors. This is especially true for us income investors who need to find that safe harbor for the coming storm.