GAMCO Global Gold, Natural Resources & Income Trust (NYSE:GGN) is a closed-end fund that is designed to generate income by applying a buy-write strategy. Such a strategy benefits from high volatility. That’s why GAMCO Global Gold, Natural Resources & Income Trust invests in the more volatile sectors of the market; commodities, and more specifically gold and energy stocks.
The GAMCO Global Gold, Natural Resources & Income Trust is an income fund. It intends to generate current income from short term gains primarily through its strategy of writing (selling) covered call options on the equity securities in its portfolio. Because of its primary strategy, GGN forgoes the opportunity to participate fully in the appreciation of the underlying equity security above the exercise price of the option. It also is subject to the risk of depreciation of the underlying equity security in excess of the premium received.
GGN is not a fund for investors who wish to participate directly in the returns from either the underlying commodities or the stocks of companies engaged in these sectors.
It is designed to generate income by investing in more volatile sectors of the market; commodities, specifically gold and energy. GGN is a vehicle for investors to participate in the natural volatility of these sectors to generate monthly income. Recently, the volatility of energy and gold stocks rose considerably.
A "Buy-Write" strategy, also known as covered calls, generally is considered to be an investment strategy in which an investor buys a stock or a basket of stocks, and also writes covered call options that correspond to the stock or basket of stocks.
Buy-Write strategies provide option premium income that can help cushion downside moves in an equity portfolio, but Buy-Writes often underperform stocks in rising markets: lower highs for higher lows.
Exhibit 1: Covered Call
Historically, this strategy has trailed the S&P 500 in double-digit return markets, but has outperformed in lower return or negative markets.
Exhibit 2: Buy-Write strategy vs S&P 500 Index
Exhibit 3: Buy-Write strategy outperformance
The differences between the share price and the NAV create discounts and premiums. Shares are said to trade at a "discount" when the share price is lower than the NAV.
Efficient market hypothesis-believers have tried to explain discounts and premiums for years with myriad explanations. Most commonly, the reason a CEF trades at any given discount or premium is related to the fund's distribution rate, regardless of the source of the distribution.
Other typical reasons for premiums and discounts include:
Overall market volatility. Recent NAV and share price performance. Brand recognition of fund family. Name recognition (or lack thereof) of the fund manager. Recent changes in distribution-policy. An asset class or investment strategy falling out of market favor. An asset class or investment strategy rising in the market's esteem.
If we compare a CEF's discount to its average historic discount, this is what we refer to as a "Relative Discount." When considering valuation, it's important to look at Relative Discounts and Relative Premiums.
Exhibit 4: GGN premium/discount
GGN is authorized to repurchase the fund’s common shares in the open market from time to time when such shares are trading at a discount of 7.5% or more from NAV. When GGN is trading at a premium to NAV, it may issue shares pursuant to its shelf registration statement in “at the market” offerings. This helps to limit the extent of both premiums and discounts.
Currently the fund is trading at a discount of 5.1%, while on average the fund was trading at a discount of 2.2% the past 5 years.
Exhibit 5: GGN average premium/discount
As we said before, GGN is designed to generate income by investing in more volatile sectors of the market; commodities, specifically gold and energy. It is not a fund for investors who wish to participate directly in the returns from either the underlying commodities or the stocks of companies engaged in these sectors. But rising prices have a positive impact on the NAV of the fund.
Because of the high level of implied volatility associated with these underlying equities, the manager generally chooses to write these options for terms of between two and six months, struck at price levels approximately 6% to 12% higher than the then-prevailing price. So preferably underlying securities rise 6% to 12% and do this in a very volatile way such that the fund receives high premiums on the written call options.
Commodities in general and metals and energy prices are heavily influenced by the dollar because they are priced in dollars. So when the dollar gains, commodities drop and vice versa. So GGN benefits from a weakening dollar and certainly when the dollar does this in a very volatile way.
To sum up: in a Blue Sky scenario for investors in GGN we have simultaneously
A final Blue Sky scenario-condition is the fund trading at a discount, preferably greater than the 5-year average discount of 2.2%.
The dollar isn’t really weakening and the past year was not the best one for gold and energy stocks, as you can see on the below graph of the VanEck Vectors Gold Miners ETF (GDX) and the Energy Select Sector SPDR ETF (XLE). Although both are showing signs of bottoming out.
Exhibit 6: Gold and energy stocks
But we are more interested in the volatility of the gold and energy stocks. The CBOE Options Exchange now applies its proprietary CBOE Volatility Index® (VIX®) methodology to create indexes that reflect expected volatility for options on select exchange-traded funds (ETFs).
CBOE calculates and disseminates the CBOE Energy Sector ETF Volatility Index, which reflects the implied volatility of Energy Select Sector SPDR ETF and the CBOE Gold Miners ETF Volatility Index, which reflects the implied volatility of the VanEck Vectors Gold Miners ETF.
Exhibit 7: CBOE Gold Miners ETF Volatility Index
Exhibit 8: CBOE Energy Sector ETF Volatility Index
This rising volatility bodes very well for GGN’s premium income!
A buy-write fund can generate high income. It makes perfectly sense to target the more volatile sectors of the equity markets (like gold and energy) in order to receive higher premiums. This is exactly what GGN does.
A few months ago, the environment wasn’t very favorably for GGN. The dollar was strong, gold and energy prices and stocks were trending down and the volatility of the latter was rather low. In these circumstances one would expect the fund to trade with a discount, but this was not the case.
In the meantime, the fund switched from trading at a premium to trading at a discount (bigger than the average historical discount) and the volatility of the gold and energy stocks started to rise. If gold and energy stocks would move higher, the picture would be perfect. It’s too soon to claim that those stocks are in a clear uptrend, although they are showing signs of bottoming out. They probably will need a weaker dollar for a sustained uptrend.
The two main conditions (trading at a discount and volatile gold and energy stocks) are certainly fulfilled and this bodes on the one hand well for the premium income and gives on the other hand a margin of safety for income investors contemplating an investment in the GAMCO Global Gold, Natural Resources & Income Trust.
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