Written by John Lounsbury
Many criticize gold as an investment because does not pay interest or a dividend. Credit Suisse has answered that charge with a new ETN (Electronically Traded Note), NASDAQ:GLDI. The name for this new security is Gold Shares Covered Call ETN. It tracks the Credit Suisse NASDAQ Gold FLOWS 103 Index (^QGLDI).
The idea is that one can derive income from selling covered calls on shares of the ETF (Electronically Traded Fund) SPDR Gold Shares (NYSE:GLD) and use the premiums collected as a source of income from “owning gold.”
The term “owning gold” is in quotes because no gold is actually owned. The ETN creates a synthetic position designed to replicate the gold flows index which is based in part on the value of gold. The index is designed to capture up to 3 percent gain in the price of gold each month and fully participates in any monthly declines.
The prospectus for GLDI provides hypothetical data (graphically) for the past four and a half years starting with June 2008. The following graph shows three values over time starting 03 June 2008.
Click on graph for larger image.
The value of the index (and therefore the approximate market value of an original hypothetical $10,000 investment) was $6611.18 on 19 October 2012, the actual inception date of the index (red line). The total of all hypothetical payments received from 03 June 2008 to 19 October 2012 is approximately $7,500. That total of payments plus the value of the index is shown by the green line.
The blue line represents a situation which cannot be accomplished. It is the hypothetical return that could be achieved with distribution reinvestment, which is something not offered. For a very large account something approaching the blue line might be achieved by using each distribution to purchase new shares. However, this possibility is not discussed in the prospectus.
Why Has the Index Declined – Hasn’t Gold Gone Up?
There are two reasons why the index has declined:
- There have been some months with large declines in gold prices, in particular the autumn of 2008 and the autumn of 2011. Remember the upside is limited to 3% maximum each month, but the downside is unlimited.
- Each month the notional calls that have been “sold” are “bought” back (covered) in order to roll to the next month’s “call writing”. The cost of covering is deducted from the index. This can offset some of the gain from the rise in GLD.
There have been five months since June 2008 with declines in the index of 5 percent or more and three of them were greater than 10 percent. While the net of results for the other 46 months was a positive for the index, it was not sufficient to completely offset the five big losers which together produced a loss of nearly 58 percent.
What Has Gold Done Since 03 June 2008?
From 03 June 2008 (when GLD closed at $89.37) to 19 October 2012 (closed at $166.33) owning physical gold produced a total return of 86 percent. That compares to a return on GLDI (hypothetical) of approximately 41 percent. Clearly the return on GLDI would have been far less than just buying GLD.
What Then Does GLDI Do?
Before continuing I must point out that there are conditions under which the Credit Suisse NASDAQ Gold FLOWS 103 Index tracked by GLDI can advance. But most of the scenarios outlined in the prospectus cover situations in which the index suffers losses over a ten year hypothetical period. One of the scenarios shows a loss exceeding 96 percent.
Of course the ETN is making coupon payments every month. As mentioned above the hypothetical payments for the 4 year 3 month period from 03 June 2008 to 19 October 2012 totaled approximately $7,500. These are shown in the following graph from the prospectus:
Click on graph for larger image.
If the payments were multiplied by the factor (10/4.25) they would amount to approximately $17,600 for the ten years. If there were no value left in the index after exactly ten years this would amount to a 76% total return or a little less than 6 percent compounded annually. This would be exactly the same as buying GLD for $89.37 on 03 June 2008 and selling it on 02 June 2018 for $157.29. In making the above comparison taxes have not been considered.
But, what if the index did not go to zero in ten years? If we continue the same decline that has been experienced since 03 June 2008, the index would be around $2,000. Then the total return for the ten years would be around 96 percent or nearly 7 percent compounded annually. That would correspond to holding GLD for the ten years and selling for $175.17.
GLDI is a Vehicle to Monetize Gold
It is wrong to look at GLDI as an investment in gold that pays dividends (or interest). It is best viewed as way to monetize gold over a period of time. It is something like a variable payout rate annuity that is producing payments that are a combination of “earnings” and return of principle. It will be paid out until some time in the future determined by one of the following:
- The index goes to zero;
- The 20-year termination date is reached;
- The ETN is extended to 25 or 30 years ( a Credit Suisse option); or
- Credit Suisse elects their option to accelerate termination to an earlier date.
In all but the first situations there would be (likely partial) “return of principal” at termination based on the value of ^QGLDI at that time.
There is still no investment vehicle I know of that is the equivalent of owning gold that pays a dividend. The new GLDI ETN is a way to have a stake in gold and receive monthly payments. But under many market scenarios (but not all) it will be losing principal over time, even if the price of gold goes up. It is therefore best thought of as an annuity alternative.
Those seeking a dividend with fixed bullion backing will have to keep looking for El Dorado.
- Cashing In on Gold? (John Lounsbury, Investing Daily, 05 march 2013)
- ETFs and ETNs are Different, and You Better Know How (John Lounsbury, GEI Investing, 24 February 2013)
- ETFs vs. ETNs: Know What You’re Buying (John Lounsbury, Investing Daily, 19 February 2013)
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