GGN: Constant NAV Destruction Ruins This Gold-Themed CEF

Summary

• Gold has been a pretty solid asset class to be in this year as uncertainty and fears of inflation have pushed investors into it.
• The fund invests in gold miners and to a lesser extent energy companies that are located around the world, providing a reasonable amount of diversity.
• The Federal Reserve's balance sheet ballooned this year and will likely to continue to do so going forward.
• The fund has underperformed both the gold miners index and the metal itself by quite a lot over the years.
• While the current discount is appealing, the fund's track record of declining net asset value makes it very much a second drawer choice for an investor.
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Gold has been one of the best performing assets ever since the COVID-19 pandemic. There are a few understandable reasons for this, most particularly because gold is generally considered to be a safe haven asset in uncertain times. Thus, many would flee into gold in an attempt to keep their money safe in the early stages of the pandemic when admittedly nobody knew what was going on. In addition, the fact that the Federal Reserve and the various governments around have essentially been printing money in order to finance the giant amounts of stimulus that they were unleashing to support their economies led people to look for alternatives to cash. Unfortunately though, one of the biggest problems with gold is that it does not actually produce any income, thus it may not be especially appealing to income investors or others that need to generate money off of their portfolios rather than simply preserve wealth. Fortunately, there are ways around this such as investing in a gold-focused closed-end fund. In this article, we will take a look at the GAMCO Global Gold, Natural Resources & Income Trust (NYSE:GGN), which is one of the more well-known funds in the space. The fund current boasts a massive 10.23% yield, which will undoubtedly appeal to anyone seeking income.

About The Fund

According to the fund's web page, the GAMCO Global Gold, Natural Resources & Income Trust has the primary objective of generating a high level of current income with a secondary goal of capital appreciation. This may seem unusual to those investors that are used to open-end mutual funds as many of those funds are much more interested in capital appreciation than in income but it is certainly not unusual among the closed-end fund space as many of these funds focus primarily on income. One thing that is somewhat unique in the space is the strategy that this fund employs to accomplish its goals. The GAMCO Global Gold, Natural Resources & Income Trust certainly lives up to its name as it invests its assets into equity securities of companies invested in the gold industry or the natural resources industry.

Although the fund does have the ability to invest in natural resources stocks such as energy companies or ordinary miners, it is currently focused primarily on gold and precious metals companies. We can see this quite clearly by looking at the largest positions that are held by the fund. Here they are:

Source: Gabelli Funds

We can see companies all across the precious metals space here. Firms such as Barrick Gold (GOLD), Kirkland Lake (KL), and Newmont (NEM) are senior gold miners. They generate their income by actually pulling gold and other precious metals out of the ground and selling them. We also see precious metals streaming companies such as Franco-Nevada (FNV) and Wheaton Precious Metals (WPM). These companies generate their income somewhat differently as they essentially just finance the development of a gold mine in exchange for a percentage of the gold or other metals from the mine, which they then sell. In addition, the risks are somewhat different as mining companies have to incur the risks and costs of developing mines that may not be as productive as they expect. Precious metals streaming companies have some of the same risks, although they can mitigate the lack of productivity by setting a minimum quantity of gold that they must receive from the mine and do not have the expenses of exploring for new mines. A precious metals streaming company may also have somewhat lower political risk as it does not actually operate the mines. The stock prices of both types of company do generally track the price of gold, though. This makes a great deal of sense since these companies typically see their profits increase when gold prices do. It is important to note that these are operating companies though and are not exactly the same thing as holding the actual metal. A company can go bankrupt, get its mines seized, or have other things happen independent of holding the actual metal. Thus, they may not be as effective at actually protecting an investor's wealth. The fund itself does not actually own any gold or precious metals.

One other thing that we notice here is that not all of these are American companies. This could be a good thing in an industry like mining due to the protection that it can provide against regime risk. Regime risk is the risk that a government or other authority will take some action that proves to be hostile or have a negative impact on the company's operations. There are many governments that have become notorious across the mining industry for doing things like nationalizing mines. The only realistic way to protect ourselves against occurrences like this is to ensure that our operations are located in many different countries and regions of the world. While all of these companies are based in areas like the United States and Canada that have a great deal of respect for property rights, their mines are scattered around the world. Thus, we do appear to have a great deal of protection against the adverse actions of any individual nation.

We can of course also see that the fund holds some giant energy companies like ExxonMobil (XOM) and Chevron (CVX). This is a sector that has certainly not performed well in the aftermath of the COVID-19 pandemic as the generational low oil price levels have wreaked havoc across pretty much all of the companies in the sector. Fortunately though, things have started to improve now that the development of a COVID-19 vaccine and stimulus hopes have made the market somewhat optimistic that American life may soon return to normal. This would likely result in an increase in energy prices and thus improve the fortunes of these companies. The fund seems to expect that this development will lead to an improvement in the price of these stocks and is thus hoping to take advantage of this.

The final thing that we note here is that the GAMCO Global Gold, Natural Resources & Income Trust is very highly diversified, well as diversified as we can get when we are focusing on one specific industry. As my long-time readers on the topic of closed-end funds are likely well aware, I do not generally like to see any one position account for more than 5.0% of a fund's portfolio. This is because this is about the level at which a position begins to expose the portfolio as a whole to idiosyncratic risk. Idiosyncratic risk is the risk possessed by any asset that is independent of the market as a whole. This is the risk that some event will occur that causes the price of a stock to fall when its broader market peers do not. It is the risk that we aim to eliminate through diversification. Unfortunately though, if an asset accounts for too much of the portfolio then this risk is not completely diversified away. Therefore, should some event occur that causes the price of that highly-weighted stock to decline independently of the market, it may end up dragging down the whole fund with it. As we can clearly see above, there is only one company (Barrick Gold) that accounts for more than 5% of the portfolio and even it is not too far above that level. Thus, the fund does appear to be reasonably well-diversified. This is rather nice to see.

Why Invest In Gold?

As was mentioned in the introduction, gold has been one of the best performing asset classes this year. As we can see here, the price of the metal was at $1,514.75 per ounce at the start of the year and has since risen to $1,879.75 per ounce today, which is a 24.10% increase:

Source: Gold.org

One of the reasons for this is the extreme uncertainty that the world faced this year. For the first time ever, a worldwide pandemic caused nations all over the world to shut down their entire economies and left a great deal of uncertainty as to when things would return to normal. Gold is frequently characterized as a safe haven investment because it is one of the things that people flee into when they are scared of other things. The alone resulted in money rushing into gold during the early stages of the outbreak when everything else in the market was plunging.

The stock market soon reversed course as the United States Congress passed the CARES Act, the largest spending package in American history, which was financed by the Federal Reserve essentially printing new money out of thin air. In addition to this, the Federal Reserve unleashed its own unprecedented wave of stimulus by purchasing up assets such as corporate bonds by using newly-printed money. We can see evidence of this by looking at the balance sheet of the Federal Reserve. As of the time of writing, the Federal Reserve had $7.362592 trillion worth of assets on its balance sheet, the highest level that it has had in history. At the start of the year, the bank's assets were $4.173626 trillion, so the Federal Reserve has purchased approximately $3.19 trillion worth of assets this year, which is by far the largest one-year increase in history, greatly dwarfing the volume that it purchased to combat the Great Financial Crisis. This value is also substantially above the roughly $800 billion that it consistently held prior to 2008:

Source: Federal Reserve Bank of St. Louis

The only way for the Federal Reserve to add assets to its balance sheet is by essentially creating new money out of thin air and then buying those assets in the broader market. As might be expected then, this buying of assets by the central bank has caused the total supply of money circulating in the economy to increase. We can see evidence of this by looking at the total supply of money in the economy. As of October 2019, the M3 money supply sat at $15.1499 trillion. As of October 2020 (the latest date for which data is available), the figure sits at $18.812 trillion, representing a $3.6621 trillion increase in just a single year:

Source: Federal Reserve Bank of St. Louis

This surge in the money supply has led to fears that we may experience inflation at some point. Economists generally define inflation as a broad-based general increase in prices. It is the result of the money supply growing more rapidly than the production of goods and services in the economy because that means that more money is available to purchase each individual unit of production. The economy's total production is measured by gross domestic product. As we can see here, the gross domestic product of the United States has gone from $15.079917 trillion in the third quarter of 2019 to $21.157122 trillion today, a 40.30% increase:

Source: Federal Reserve Bank of St. Louis

Obviously, the money supply has been climbing much faster than the production of goods and services in the economy has. This is the kind of environment that is conducive to inflation. Admittedly, so far that inflation has been fairly muted outside of asset prices because the newly-printed money has not made its way into the broader economy. It may at some point though once people decide to spend their newfound wealth and once that happens, inflation results. This is in fact the Federal Reserve's goal with this money printing as the central bank has consistently stated that it wants to achieve an average inflation rate of 2% annually. Thus, it seems likely that we will see the current trend of money supply growth continue going forward.

Gold benefits from the same factors that cause inflation. This is because the supply of gold is limited to the existing supply plus what the world's gold mines can produce. All of these mines combined can only increase the above ground supply by about 1-2% annually and obviously the money supply is increasing much more rapidly than that. Thus, an increasing amount of money is available to purchase each unit of gold. This is why investors purchase gold as a way to protect their wealth when they fear inflation. This is conducive to a long-term steady rise in gold prices, which should also prove to be a good thing for gold stocks.

Performance And Finances

As already shown, the price of gold has been on something of a tear this year. This is reflected in the gold miners index, which is tracked by the VanEck Vectors Gold Miners ETF (GDX), which is up 27.63% over the past year and 168.28% over the past five years. The GAMCO Global Gold, Natural Resources & Income Trust has not performed nearly as well. As we can see here, the fund's net asset value per share has been roughly cut by a third over the past five years:

Source: Gabelli Funds

This is obviously concerning since it may be a sign that the fund is paying out more to its investors than it is actually making in off of its investments. Thus, we should investigate this because a fund cannot sustain a distribution that is in excess of what it makes in the form of dividends or capital gains indefinitely.

In the first six months of the year, the fund received a total of $7,691,984 in dividends and $880,794 in interest. It paid $4,698,940 in total expenses out of this income, which gives the fund a net investment income of $3,873,838. It also suffered net realized and unrealized losses of $7,836,288 off of the securities that it invested in. The fund overall saw its net asset decline by $10,000,481 after it made the required payments to the preferred shareholders. Obviously an investment in the gold miners ETF would have served an investor far better. Despite suffering a loss, the fund still paid out $49,094,316 to its shareholders. Obviously, the fund could not afford this distribution over the first half of the year.

Fortunately, the fund did do better last year. It generated a net gain from all sources after expenses of $102,974,611 and only paid out a total of $86,164,964 in distributions to common shareholders. Thus, it was able to afford its distributions last year and the net asset value per share did increase as a result. However, it is important to keep in mind that 2009 was a great year for the market in general in which we saw nearly all sectors perform very well. The long-term history of value destruction is very worrying, however.

Valuation

As is always the case, it is critical to ensure that we can obtain any asset that we are investing in at a reasonable price. This is because overpaying for any asset in our portfolio is a surefire way to guarantee that we generate a sub-optimal return off of these assets. In the case of a closed-end fund like the GAMCO Gold, Natural Resources & Income Trust, the usual way to value it is by looking at a metric known as the net asset value, which is the total value of all of the assets in the fund's portfolio minus any outstanding debt. It is therefore the amount that the fund's investors would receive if the fund were immediately shut down and liquidated.

Ideally, we want to purchase a fund when it is trading for a price that is below the fund's net asset value. This is because such a scenario essentially means that we are acquiring the fund's assets for less than they are actually worth. Fortunately, that is the case right now. As of December 16, 2020 (the latest date for which data is available as of the date of writing), the GAMCO Global Gold, Natural Resources & Income Trust had a net asset value of $4.00 per share but the fund is only trading for $3.52 per share. Thus, the fund is currently trading at a 12.00% discount. While this is certainly a fairly large discount, it may not represent a value given the fund's history of value destruction.

Conclusion

In conclusion, there are certainly many reasons to own gold or gold stocks in today's environment. As the Federal Reserve currently seems highly unlikely to stop increasing the supply of money in the economy until inflation begins in earnest, owning gold now could help you protect your wealth when that day comes. While the GAMCO Global Gold, Natural Resources & Income Trust is one way to gain exposure to the precious metal, it would certainly not appear to be a great way due to its long-running track record of value destruction as shown by its steadily declining net asset value over time. Overall, there are better ways to protect your wealth with gold than this fund.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.