With market volatility still at well above average levels, the COVID-19 outbreak still wreaking havoc on the global economy and trillions of dollars of Fed stimulus threatening to spike long-term inflation expectations, gold and gold miners are starting to look as attractive as they have in years.
Gold is threatening to test the $1800 level and gold miner stocks have finally caught up on the rally.
I'm a firm believer that the rally in gold is not over. The coronavirus recession is ramping up deflationary pressures, but the long-term view still looks very inflationary. With interest rates at record lows, trillions of dollars being pumped into the economy and debt levels soaring, it feels almost inevitable at this point that prices will start spiking.
After all, what's going to happen when the economy reopens and consumers armed with all of this cheap money and ultra-low interest rates start opening their wallets?
One good way to play the pending rally is the GAMCO Global Gold, Natural Resources and Income Trust (GGN).
It’s a fund that invests mostly in gold miners & energy companies and layers on a covered call option strategy in order to produce a high yield.
But GGN has a potential problem. It just announced a 40% cut to its monthly distribution from $0.05 to $0.03.
Distribution cuts are nothing new for GGN, but it’s not altogether surprising given the industries it operates in. The covered call strategy has been able to generate a modest amount of income for the fund, but equity funds generally require capital appreciation to make up the difference for its managed distribution policy.
We can see from the distributions of the past couple of years that GGN has required a significant return of capital in order to support the distribution.
The distribution cut wasn’t surprising and, in fact, it may set the fund up much better for the future. Given the rally we’ve seen off the bear market bottom in both gold miners and energy stocks, the fund may finally be producing the capital gains that could support the distribution going forward.
The distribution cut puts GGN’s current yield at about 10.5%. That’s below the traditional range of 12-16% that it’s typically been in over the past several years. On the surface, the lower yield would seem less attractive, but I actually feel better about it coming out of the distribution cut. Based on the direction of underlying asset prices and economic trends, the former 16% yield was flashing warning signs that it was unsustainable. The new distribution rate, while lower, feels like it’s on a more sustainable footing.
The biggest short-term selling point for GGN is its discount to NAV.
GGN has traded at a premium to its NAV more often than not over the past decade. Rarely has been the case where it’s traded at a double digit discount, but that’s where it is right now.
Discounts have no guarantee to shrink back to their former levels, but it seems like a good bet for GGN. Given how the energy sector has been deeply out of favor, how equities are still recovering from bear market lows and its premium/discount history, I believe it’s a matter of time before the discount shrinks, allowing an extra capital appreciation opportunity for astute investors.
The energy sector has staged an impressive comeback over the past couple of months, but I think the current rebound is fully valued in. Gold and gold miners, however, have more room to run. The long-term inflationary pressures fueled by a mountain of Fed stimulus will inevitably spike consumer prices and that will be a bullish backdrop for gold.
As the markets continue to recover, I expect the discount to continue moving towards 0% making GGN a likely outperformer. The 10% yield feels like it’s on much firmer standing following the cut making the fund attractive from both a growth and income standpoint.
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