Metal Gets Less Precious

“Commodities have done well over the past decade and gold gives a portfolio diversification,” said Lawrence Carrel, author of ETFs for the Long Run (Wiley, 2008). “Physically backed gold ETFs give you liquidity and a good proxy for the spot price of gold.”

But Carrel warns that gold is taxed at higher rates compared to equities, plus it doesn’t generate any earnings. “Gold probably shouldn’t be more than 15 or 20% in a portfolio,” adds Carrel. 

A new ETP called the Gold Shares Covered Call ETN (GLDI) attempts to generate cash flow on gold by selling covered call options.

“Gold is often criticized as a portfolio investment because of its lack of any yield,” said Greg King, head of exchange-traded products in Credit Suisse’s Investment Bank. “Covered call strategies however, are designed to enhance yield in exchange for sacrificing part of the upside of an investment position. GLDI seeks to provide investors and their advisors an interesting new way to introduce monthly cash flows into their portfolios.”

Advisors that don’t like the GLDI’s ETN structure because of its credit risk have other choices. Selling covered call options on physically backed ETPs like the SPDR Gold Shares (GLD) or the iShares Gold Trust (IAU) is another option.

In a covered call strategy, an investor holds a long position in an asset and sells call options on that same holding. Call options provide the seller with an upfront premium payment, but require the seller to deliver to the buyer any upside an asset experiences beyond a set level. 

While holding possession of physical gold may have certain psychological comforts, it has its drawbacks. For instance, one of the disadvantages of owing physical gold as coins or bars is they can’t be easily hedged against price declines. On the other hand, gold equity and physically backed gold ETPs can be protected with insurance or put options.

Purchasing a put option on GLD, for example, could minimize the impact of a severe downturn in gold. Any losses in the value of GLD would be offset by gains in GLD put options. It’s this sort of financial flexibility that gives gold investors more choices versus holding physical bullion. 

Keeping Perspective 

Precious metals have the historical tendency to go through long periods of boom and bust. After peaking in 1980 at $850 per ounce, physical gold was dead money for 20 years. Then, just as it seemed gold would continue to lifelessly linger, it began a streak of 12 consecutive yearly gains in 2000. 

Gold education is an important aspect of the equation. Income oriented investors, particularly retirees, should have a very small amount of their money allocated to precious metals. Some advisors forgo exposure to metals altogether, opting instead for commodity focused equity sectors like basic materials (XLB) that pay a small dividend. Ultimately, advisors will have to decide what’s best on a client by client basis. 

“I believe that exposure to gold should play a part in the alternative investment bucket of a well-diversified investment portfolio for most long-term investors,” said Christopher Tasik, CFP, with Tasik Financial Strategies in New York. “When appropriate I utilize gold ETFs in my client portfolios.”  •