Watch Out For Gold Miners ETF Income And Capital Gains Distributions In December

Includes: GDX, GDXJ, GLD
by: Michael Murphy, CFA

The Market Vectors Gold Miners Exchange-Traded Fund (NYSEARCA:GDX) and the Market Vectors Junior Gold Miners Exchange-Traded Fund (NYSEARCA:GDXJ) each will pay a capital gains and income distribution on December 23. ETFs, like any registered investment company, are required to pay their shareholders 90% of their realized capital gains and net investment income each year in order to maintain their tax-free status.

Each of these funds tries to minimize capital gains. Because they are exchange-traded funds, shareholders do not normally redeem shares in order to cash out. Rather, the sell their shares to someone else who wants to hold the ETF. So the funds are not forced by redemptions to sell their underlying securities and realize capital gains and losses, as open-end funds with net redemptions may be forced to do.

Van Eck Securities, the investment adviser to these ETFs, expects GDX to pay an income dividend of 9.5 cents per share, no short-term capital gains, and a long-term capital gains distribution of about 60 cents a share. The ex-dividend date is December 23, the record date is December 28 and the payment date is December 30.

GDXJ also will not have any short-term capital gains. The long-term capital gains distribution will be about 68 cents a share, about 2.3% of the fund's value. But the complication comes in the income. Both GDX and GDXJ owns stocks in companies classified as Passive Foreign Investment Companies - non-U.S. corporations having 50% or more of their assets invested in cash or securities, or having 75% or more of their gross income originating from passive sources, including but not limited to interest, dividends and rents. In other words, these foreign companies primarily derive their revenue streams from investments, rather than operations.

GDX and GDXJ have to take their share of the income of the Passive Foreign Investment Companies into their own income, and then distribute 90% of that to shareholders (net of expenses not covered by the dividends and interest on other securities, securities lending, and so on). In 2010, GDX paid an income dividend of 40.1 cents per share, 90% of which was from Passive Foreign Investment Companies. But GDXJ paid a $2.929 dividend, about 10% of the fund's value, and 100% was from Passive Foreign Investment Companies.

Van Eck has not provided an estimate for the 2011 income dividend on GDXJ yet. It could be quite large – or not. My guess is that it will be in the $1.00 to $2.00 range this year, but Van Eck should announce the distribution shortly. I will add a comment to this post at that time. Like GDX, the ex-dividend date is December 23, the record date is December 28 and the payment date is December 30.

Why is this important? If you hold either or both of these securities in a tax-deferred or tax-free account, like a 401-K or IRA, it's not. But if you hold them in a taxable account, you will be liable for the tax on the distribution even if you hold the securities at a loss. Thus, an investor who buys GDXJ on December 22 in a taxable account will have a tax obligation for 2011 for the income and long-term capital gains distribution, even if GDXJ does nothing but go down through the end of the year and the investor does not sell. Even if you buy GDX or GDXJ on Thursday, December 22, and then sell it on Tuesday, December 27 at the same price, you will be liable for the tax on the entire distribution.

For taxable accounts, it may be important to not own GDX or GDXJ on December 23. If you sell and book a profit on the ETF, you will owe the tax on your gain rather than on the fund's distribution, and you can rebuy on December 27. You will have to do your own calculations on the advantages of selling or not. If you sell at a loss, you can either call it a wash sale and rebuy on the 27th, or you could buy something similar like the SPDR Gold Shares (NYSEARCA:GLD), hold if for the required 30-day period to avoid the wash sale rules, and then sell it to rebuy the mining ETF.

Disclosure: I am long GDX, GDXJ. I am long in non-taxable accounts.

Disclaimer: I am not a lawyer or tax consultant; please contact your own professionals for personal advice on your situation.