Buying Gold Without Sacrificing Yield

by: Monty Spivak

My friend, Tim, is an investment advisor and gold bug. When I saw him a few months ago, he advised me to buy gold. He was right – gold has been appreciating over the past several months. The other perspective was the subject of a discussion with my friend Mike last week; he only wants investments which will generate his target return, and would prefer to hold 5% of his assets in gold.

There are many articles published with reasons why one should invest in gold – the Euro is falling; the US dollar is falling; there is a commodity glut, particularly for oil; China is going into recession; inflation is coming; and, governments are printing tonnes of paper money. There are additional opinions about how to invest in gold. Some of the popular ones include recommendations to buy gold bars/bullion; buy gold mutual funds; buy ETFs (Exchange Traded Funds) of physical gold, certificates, gold mining stocks; and, other variations, such as investments in global precious metal funds or shares.

The conclusion that I reached is that, in order to hedge my risks, I should place at least some of my assets in gold. It is not that I believe that the financial world as we know it will end. It just seems prudent to hold a small percentage of my assets in a currency that has a well-defined supply and global demand. You may prefer to hold 5%, 10% or more, of your assets in gold; I believe that you need to define your own comfort level. My problem – the same problem shared by Mike and many other baby-boomers – is that holding gold does not provide a reasonable dividend.

Seeking capital gains, I used to buy securities that do not pay dividends; those days are gone. My experience over the past two years is that “buy and hold” did not work for any sector or geography in which I had invested. I am not challenging the concept that a growing company will provide opportunities for capital gains – which is an increase in the value of the security - or that capital gains may provide a better after-tax return. Rather, I have experienced certain issues with shares which do not pay dividends: 1. One must sell the investment to realize the gain. 2. Effort is required to buy-low and sell-high – you need to pay attention to the price changes. 3. If you select the wrong security, then you do not realize any return. When you purchase securities which pay interest, dividends, or return capital, then you receive periodic payments. They are subject to certain risks, but on average, your money will earn you something. I believe that my investment dividend yield should, at a minimum, cover my opportunity cost, which is the cost of an alternative investment. I have chosen the “no risk” 5-year Canada Bond rate of 3.5% as my hurdle. This has become the source of the gold-investment problem. How could I generate a yield which exceeds my minimum rate, in order to invest up to 5% of my assets in gold?

Gold Mining Stocks

It has been argued that gold miners either follow, or do not correlate to the gold price. Whether this is statistically meaningful or not, my belief is that the price of gold – over the period of 1 or 2 years – would be reflected in the share price of the gold mining companies. Is this not true for oils, gas, copper, and other commodity producers? Therefore, one can propose that gold mining companies would provide a proxy for a gold-tracking investment.

There are various excellent articles that explore how the market price for gold and the share price of gold mining companies behave similarly. Recently, Graham Summers proposed that over a 10-year horizon, gold miners follow the gold market price more than they follow the general stock market, however in the short-term, gold-mining companies behave like stocks. He stated: “What does this mean? If a Crash were to hit tomorrow, mining stocks would likely fall along with the S&P 500. However, they would fall less, rebound more quickly, and outperform the general market.” One can extrapolate this to propose that holding a basket of gold-mining stocks will have similar risk-mitigation characteristics to holding gold bullion.

Unfortunately, one can forget about gold producing companies as an investment which will meet the dividend yield hurdle. Few gold mining companies pay dividends, but there are some that do pay a “whopping” dividend of less than 1%. I have assembled a sample of large and mid-cap gold producers that are represented in many of the gold-mining funds. Please note that I treat the Canadian Dollar – the currency of many of the gold producers’ shares – and the US dollar – the price of the precious metal - as being at par.



Market Cap ($B)

Recent Price

Dividend Yield

Barrick Gold










Anglogold Ashanti





Kinross Gold





Agnico-Eagle Mines





Gold Fields Ltd.





Randgold Resources





Yamana Gold Inc.










Semafo Inc.





Clearly, these would not meet an investment criterion which demands a dividend yield of 3.5%. This leaves us with a choice of funds. There are a lot of gold funds, and a lot of types of gold funds. Some hold gold bars/bullion; others hold gold certificates; a few hold gold mining company shares; some funds hold not only gold, but other resources and precious metals, as well (which would be handy, if you would want to diversify your gold holdings with other rare metals).

Gold Mutual Funds and Exchange Traded Funds

I do not subscribe to buying gold mutual funds. I propose that, generally, mutual funds, and particularly Canadian mutual funds, have high Management Expense Ratios (MERs). The MER is the fee that the fund company charges you for managing your money, before they pays you a return. Let’s look at a possible scenario. You holdings – in this case, gold – may increase in value by 2% annually, but if the MER is 3% per year, then you earn -1% for the year. MER is charged on your total holding, rather than your earnings, so losing money does not cost the mutual fund company anything. Over periods when gold does not appreciate, such as periods with low inflation, your “store of value” in the gold mutual fund is reducing in value by the amount of your MER. There are certain circumstances which may make a mutual fund an attractive investment vehicle, but I have not found one that invests in gold, matches my yield criterion, and has a low MER.

Perhaps an Exchange Traded Fund is a good way to hold gold? These are a variation on mutual funds, but are traded on stock exchanges, and have lower MERs. Despite the lower fees, do not hold your breath to wait for a substantial and regular dividend. These are not managed funds; rather they track the behavior of a basket of securities. This means that if the underlying securities are stingy dividend-payers, then the fund will be, as well. If your goal is to hold gold for capital appreciation, then this may be the most convenient mechanism. Historically, I never seem to be able to execute against “buy low and sell high” – my capital gains do not compare to the reported statistics on fund values. Instead, I am seeking a regular, quarterly dividend. There are many gold ETFs, but I am challenged to find one that meets my dividend-paying requirements.

Closed-End Gold Producer Funds

What you may want to consider is a Closed-End Fund, with a managed distribution. A closed-end fund is a basket of securities that are held in a fund. The fund is traded as a security on the stock market. As with any share, they will trade at a premium or discount to the value of the pool of underlying assets – depending upon what the market will pay. For example, a closed-end fund trades under its own ticker symbol on the TSX, and may hold as its assets, shares of 100 gold mining companies. Many CEFs are income oriented, and the majority of them are leveraged. Leverage means that they borrow money and use the borrowings to invest in their designated asset class – in our case, gold securities. Through a larger investment in the underlying securities, leverage generates more income for the fund, but makes it more sensitive to interest rate and market fluctuations. Basically, it would cause a gold fund to behave more like a fund and less like the underlying commodity. Therefore, if you want a gold fund that behaves like gold, then you would prefer one with less leverage.

Where we get the yield is through the managed distribution policy. Some of these funds institute a distribution policy which provides the shareholder with a consistent dividend. Regardless of whether the earnings or assets have increased or decreased over the period, the managed distribution policy is maintained. There are instances – typically when a fund is experiencing financial pressures – that the distribution is reduced - but this is relatively uncommon.

Do not confuse yield with dividend distribution. For a CEF, these are very different, and this is the major risk of this form of investment vehicle. Some gold CEFs provide annual yields from 5% - 15%. If a CEF does not earn what it pays-out, then the difference is paid to the investor as a return of capital. This reduces the fund’s Net Asset Value (NAV) by an equal amount. For example, if a gold fund which invests in covered calls on its underlying gold-producer stocks is earning 5%, and is paying out 7%, then the NAV is being eroded by 2% in that year. An excellent example is Gabelli Gold distribution. Although the Yield is over 10% for Gabelli Gold, the Income Only Yield was only 1.44%. The impact is that the NAV progressively reduces over the years, as the payout increasingly exceeds the earnings by greater amounts. This is a motivator for the CEFs to issue new shares and warrants to maintain their capital base, which in fact, all of the CEFs listed below do with great regularity. The influx of new capital permits additional purchases of securities in the funds; the goal is to productively invest the new money to increase the NAV for the current and new shareholders. Investors should understand that the price they pay for their high cash yield includes the risk of a decline in the NAV and market price, over time. In other words, the higher the yield, the faster the decline in NAV.

The return of capital is not unique to CEFs. In fact, the best example of the return of capital model is employed by the yield from Real Estate Investment Trusts (REITs), and in Canada, various other business trusts. A substantial portion of a typical REIT yield is paid as a return of capital. This provides for the higher yields and lower taxation, which is mirrored by the CEF distributions.

Now for the big question… How can funds of gold-producing companies which do not pay dividends, pay you quarterly (or monthly) dividends? Well, the fund manager actually needs to perform some work and earn their fee! There are three methods; they receive some meagre dividends from their holdings; they buy and sell the gold-producer shares to generate capital gains, and; they buy and sell options on the underlying securities. We have already explored the dividend yield – this provides a very small part of the total yield. Generating capital gains is fairly obvious; many shares trade in a relatively-defined range and the fund manager needs to buy near the bottom of the range, and sell near the top. A more dependable and predictable income is typically generated by selling covered calls against the fund’s holdings.

As defined by Trading Online Markets LLC:

An option is simply the right, for a specified period of time, to buy or sell an item at a guaranteed price. Therefore, stock options are rights to buy or sell shares of stock at a guaranteed price during the life of the option.

A covered call is a type of option where the CEF, which owns the underlying shares, sells the right for someone else to buy these securities. The purchaser may or may not exercise their option, but the seller is guaranteed his fee.

This is not to provide the reader an education on how derivatives work, but to explain how the fund assets – the gold-producer shares – generate a stream of fees for the CEF. A good example is Semafo – an intermediate-sized gold producer, with production and exploration in West Africa. It is the largest holding of Sentry Select’s Precious Metals and Mining Trust. Currently, and is trading around $7.55. On the Canadian derivatives exchange, one can earn fees selling Semafo covered calls. They currently range from $0.10 to $3.40/share, depending upon the contract date and strike-price. Semafo’s 52 week trading range is from a high of $7.94 to a low of $1.85. The return on the options with this volatility is magnified, which probably makes Semafo a strong candidate for this type of fee-generating activity. This is how the CEF earns fees with the gold-producer shares, and is an important source of the income stream to support the CEF yield.

There are a few in the Canadian and US markets. Each has its own risk profile and strategy. Here are a few that CEFs for you to consider (prices, NAVs, and Market Cap from 2010-05-31 to 2010-06-11):



Market Cap

Recent Price

Recent NAV



Gabelli Gold







Precious Metals







Gold Participation







Faircourt Gold







MER includes Management Fees and Expense Ratios, which are charged by the manager – and by the manager of funds held within these CEFs - against the NAV of the fund.

Despite similarities, each of these funds has its own unique composition. The differences between their investment approaches and holdings may determine your choice. For example, some of these funds may not have the diversification or type of holdings that you seek.

CEF Name


Description of Holdings and Investment Strategy

Top 10 Securities Holdings

Gabelli Global Gold Natural Resources & Income Trust

(Gabelli Funds Inc.)

Invests at least 80% of its assets in equity securities of companies principally engaged in the gold industry and the natural resources industries. Currently about 63% is in metals and mining, with much of the remainder in oil and gas.

The Top 10 – each a little over 2% weighting - collectively represent around 20% - 25% of the total portfolio.

Randgold Resourcs Ltd.

Gold Fields Ltd.

Agnico-Eagle Mines Ltd.

Anglogold Ashanti Ltd.

Freeport-McMoRan Copper & Gold

Newcrest Mining Ltd.

Kinross Gold Corp.

Xstrata plc

Barrick Gold Corp.

Lihir Gold Ltd.

Precious Metals and Mining Trust*

(Sentry Select Capital Inc.)

The Trust focuses on companies engaged in the exploration, mining and production of gold, diamonds, uranium, copper, zinc and other metals and minerals in North America.

The top 2 positions represent almost ½ of the portfolio holdings - SEMAFO Inc. (37.12%)

and Golden Star Resources Ltd. (11.20%). The Top 10 holdings total 80% of the fund’s portfolio.


Golden Star Resources Ltd.

Red Back Mining Inc.

Alamos Gold Inc.

Osisko Mining Corp.

Yamana Gold Inc.

Gold Wheaton Gold Corp.

Aurizon Mines Ltd.

Globestar Mining Corp.


Mulvihill Gold Participation and Income Fund*

(Mulvahill Capital Management)

The Trust invests its net assets in the gold sector.

The fund is heavily weighted in SPDR Gold Trust – in fact, about 47% of the NAV is invested in shares of SPDR Gold Trust, 11% cash, and 42% in the Managed Gold Portfolio, which consist of equity securities selected from the S&P/TSX Global Gold Index.

SPDR Gold Trust

Barrick Gold Corporation

Newmont Mining Corporation

Goldcorp Inc.

Red Back Mining Inc.

Kinross Gold Corp.

Alamos Gold Inc.

Osisko Mining Corp.

Semafo Inc.

Rubicon Minerals Corp.

Faircourt Gold Income

(Faircourt Asset Management Inc.)

The company provides investors with exposure to global companies primarily involved in gold exploration, mining or production on the S&P TSX Global Gold Index.

The Top 10 holdings represent about 50% of the portfolio, and have reasonably proportional allocations. The largest holding – 20% in September, 2009, was cash.

Agnico-Eagle Mines Ltd.

Barrick Gold Corp.

Detour Gold Corp.

Goldcorp Inc.

Kinross Gold Corp.

New Gold Inc.

Newmont Mining Corp.

Rainy River Resources Ltd.

Randgold Resources Ltd.

Yamana Gold Inc.

* One warning: Canadian taxation is changing on business royalty trusts, which will either require GPF.UN and MMP.UN to convert to taxable corporations by 2010-12-31, or expose them to higher taxation. Therefore, their distributions are at risk of being substantially reduced by the end of 2010.

The one that you choose should match your investment style and risk appetite. In order to provide you complete disclosure, I am long on Gabelli Gold, and currently hold no other long or short gold positions. Although this alternative comingles gold with other resource investments, I like the security of the larger market capitalization, diversification of its holdings, and that it is denominated in US dollars. I am not a big believer in Dividend Reinvestment Plans (DRIPs) – and this may be a subject for a future article - but in order to retain a consistent portion of my portfolio in gold, and to reinvest my returned capital, I participate in their DRIP with this holding.

One aspect that you may want to consider is the degree of diversification within the fund. When a fund has a substantial portion of its portfolio in one security, then many analysts have the view that one should just buy the security, rather than pay the MER of the closed-end fund. The problem with this approach is that one would need to actively buy and sell options on the security in order to generate the fee income. The closed-end fund will do this for you. High volatility stocks can provide the fund managers with better opportunities to write profitable options. This may explain the lack of diversification in some of the funds – particularly those managed by Sentry Select (with a large Semafo position) and Mulvahill (perhaps not a good explanation, as SPDR has not been very volatile in the past year).

Other Considerations

If you are seeking capital gains, rather than yield, then the CEF alternative is probably not your best choice; you should probably be holding gold bullion or a gold mutual fund. Otherwise, the CEF offers the only consistent yield for gold holdings.

If you are the type of person who needs to touch your assets, then I would not try to dissuade you from buying physical gold. In fact, you should also stuff your mattress with cash, if it will help you sleep at night (pun intended). Instead, if you want a small inflation hedge, then my suggestion is to diversify your portfolio with a little gold, but “get paid to wait”. The closed-end funds may not increase in value as much as the underlying gold securities, but they will provide a more predictable return – your goal with this strategy is to manage your down-side risk by holding gold. Your gold “insurance policy” will balance your currency and opportunity-cost risks by generating a stream of dividends.

So, what would I say to my friends Tim and Mike? I would not try to dissuade Tim from holding gold, as this is his preferred strategy. I would just encourage him to hold an investment which provides a more predictable return, in order to meet Mike’s investment objective of providing an above-market yield.

Disclosure: Long GGN

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