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Three Ways to Generate Income with Gold

Tuesday, 12 Jul 2011 08:35 AM

By Andrew Packer

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“Gold isn’t an investment. It doesn’t produce any interest or dividends.”

If I had a buck for every time I heard that, well, I’d have enough to buy at least an ounce of gold. It’s a very misunderstood concept, because modern financial analysis depends largely on determining the discounted value of future cash flows.

But the presence of cash payments doesn’t necessarily make for good investing.

In the case of interest and dividend-producing assets, there’s the issue of losses. If I invest my cash into money market accounts, the interest I earn isn’t outdoing inflation. So I come out with a real loss. If I own a stock that has to borrow to pay a dividend, am I investing, or taking on the huge assumption that things will somehow work out fine in the end?
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Of course, I don’t think the statement is entirely wrong. One doesn’t own gold to invest; one owns gold to preserve purchasing power. In that sense, it’s not an investment.

While the metal itself doesn’t produce any interest or dividends, there are many ways to generate income from gold-related investments.

Using the 5-year bond yield as a benchmark (a mere 1.5 percent), there are plenty of opportunities to earn a higher yield with gold. Here are three ways:

• Big-Cap Mining Companies

Although not focused entirely on gold, most large-cap mining companies have exposure to gold. They also have dividend yields greater than the 5-year treasury. Over the next five years, they will perform well thanks to growth in emerging markets, and ongoing dollar devaluation. Of course, there will undoubtedly be bumps along the way.

Companies to consider with a yield greater than the 5-year include Rio Tinto (RIO), Vale (VALE), and Southern Copper (SCCO).

• Covered Call Writing

As I’ve written before, a covered-call writing strategy with gold stocks can produce option premiums in excess of 10 percent over a six month period. This strategy can be used with any stock that has options traded on it, however, including the mining stocks listed above.

In order to take advantage of this strategy, however, you’ll need the capital to buy shares and then stick with them until the option expires.

Your upside and downside are also limited as a result, making this strategy best for more conservative investors.

• Gabelli Gold, Natural Resources, and Income Trust (GGN)

This fund focuses on gold miners and gold-financing transactions. Its largest holdings are the usual suspects in the gold universe, namely big-cap companies like Newmont Mining, Barrick Gold, and Kinross.

Unlike investing directly in the miners, however, this fund pays its shareholders a monthly dividend to the tune of nearly 9 percent per year.

Gold is misunderstood by those who only analyze investments in terms of the cash it produces. Fortunately, a few different investments and strategies exist to generate cash from this so-called barbarous relic.

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