In a bit of a departure from my usual approach of writing to you about specific corporate stock, I thought to open up a discussion about owning gold.
For many years, I’ve held gold as a small portion of my investment portfolio. In this article, I will share my rationale for doing so, why I hold gold via the SPDR Gold Trust ETF (GLD), and how I generate a little income on it along the way.
Why Own Gold?
I understand there’s good arguments for NOT owning any of the yellow metal. Warren Buffett once quipped,
(Gold) gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.
So why bother?
Well, the primary reason I own gold is the be a hedge versus traditional equity investments. Admittedly, debates about whether gold is actually negatively correlated to equities is often defined by the chosen time period. Bottom line: at certain times gold does correlate negatively with stocks. At other times, not so much.
On balance, I think about gold as a risk-off investment.
Indeed, during times of market stress / volatility, gold has often become a safe haven. This is my primary investment thesis: gold represents an investment with a weak correlation to broad equity markets. It often zigs when the market zags. I view it as a hedge or insurance policy during times of high market volatility.
Notably, as a function of my overall portfolio, gold represents a very small fraction of it. Personally, between 1% and 5% of the total is the norm for me. My average annual portfolio gold exposure is about a percent or two.
How To Own Gold
As to the various ownership possibilities, there’s three primary vehicles:
- Physical gold — bars / bullion / coins
- Exchange Trades Funds — examples, SPDR Gold Trust, iShares (IAU), Aberdeen Standard Physical Swiss Gold (SGOL)
- Gold mining companies or Gold Miner ETFs — Newmont (NEM), Barrick (GOLD), Agneco Eagle (AEM), VanEck Gold Miners ETF (GDX), VanEck Junior Gold Miners ETF (GDXJ)
There are other less-traveled options; for example, streaming and royalty companies like Franco-Nevada Corp (FNV). These companies provide up front cash money to miners in exchange for contract rights to buy gold and other precious metals in the future at reduced prices. While I find these business arrangements interesting, they’re not aligned with my straightforward, “just own gold” thesis.
Physical gold seems to be a decent way to own the commodity; however, I find storage and associated holding costs problematic. I don’t want it lying around the house, nor am I a proponent of burying it in old coffee cans in the backyard. Where to buy and sell physical gold can be a chore, too.
Owning stock in the mining companies avoids the storage and handling problem, but it adds another new dimension: management efficiency. As with any business, some companies are better or worse at physically mining and selling gold. I’m not interested in trying to sort that out.
That leaves owning gold via an Exchange Traded Fund. There are many different gold ETFs from which to choose. Personally, I like the SPDR GLD. Why? Option liquidity. My desire for option liquidity will become clearer later in the article.
To be certain, when owning a gold ETF, one does not have access to the corresponding physical commodity. In fact, many gold bugs will insist the ETFs are not even fully backed by physical gold. (I’m anxious to read your comments about this at the end of the article.) In any event, I agree with the premise in concept: by owning a gold ETF, I cannot run down a vault and demand my investment to be paid out in physical gold. I own a piece of paper with real gold behind it; that’s not the same as owning the physical commodity.
So if I’m going paper, why not go all the way?
I prefer to control gold through long call options. SPDR Gold Trust open interest and volume runs considerably greater than any other gold ETF.
The GLD has an expense ratio of 0.40%. This is higher than the IAU or SGOL (these have 0.25% and 0.17% expense ratios, respectively). However, option open interest and volume is just a fraction of the GLD. I’m willing to pay a little more for the liquidity.
Own GLD Long Calls
My gold investment is limited to owning long-dated, GLD long call options.
Typically, I buy a set amount late in the year or very early in the proceeding year. Most often, I seek long calls ~12 months out: typically purchasing the January standard expiration calls for the following year.
For two reasons: first, I want to control as much gold as I can, for a full year, and at as low a cost as possible. Therefore, I buy deep-in-the-money calls; weighing the depth of the strike versus the lowest option premium. Generally, about one-half to two-thirds of the GLD long price is my set point.
If I were buying gold today, I’d look toward purchasing the GLD January 2021 calls; a bit over 12 months out. Currently, the GLD is priced at ~$139 a share. Therefore, I’d seek long calls with a strike between $70 and $95. Typically, calls that far out will show low open interest. That’s ok, open interest will pick up as the options mature. In the meantime, the bid / ask spreads are significant. So I look around to eyeball a reasonable price point.
Here’s a clip of GLD January 2021 options with strikes ranging from $70 to $95:
Looking at $80 strike options, the bid / ask spread is $60.05 and $60.80. In this case, I’ll determine the midpoint of the bid / ask, and place a limit order. The arithmetic says to put in a order between $60.40 to $60.45. Given the spread, one’s got to be patient.
Presuming I get a fill, it means I can control 100 shares using only a little more than 40% of the capital required to own the GLD shares long. My holding cost for saving the capital outlay is $1.38 cents (theoretical $60.43 purchase price plus the $80 strike equals $140.43 versus the current GLD bid of $139.05).
Since the option expiration is 398 days out, the math indicates I’m paying 1.5% annualized for the ability to save an $80 per share outlay to go straight long. I like those numbers.
Bottom line: for each GLD option contract, I can control 100 shares for over a year at $60.43 each instead of paying $139.05 if I were straight long.
Generating Income On the Side
Gold offers no dividends. This is one of the reasons many don’t find it an attractive investment. To the contrary, there’s holding costs or management fees to be paid. Both are drags on investment returns.
What to do?
My approach is to wait until a month or two from the option expiration dates, then write out-of-the-money short calls on my long calls.
Generally, I write these utilizing the following parameters:
- I don’t sell short calls unless there’s less than 60 days remaining until the long call expiration date. It’s not my intent to get the long calls taken from me. The objective is stay long through the year.
- Within the ~60 day window, I begin by only writing calls with an option delta less than 0.30. From experience, this offers me a very good chance of collecting the premium without getting the long calls assigned.
- The short calls are written for an expiration only a week or so out. By design, I want the duration to be short, so I can collect premiums, then re-write or roll out the calls several times.
- Often, I’m happy collecting 90% of the premium on the short calls, then buying these back and rolling out a new set of calls another week out.
Remember, the initial objective is to generate income without having the long calls assigned.
However, as the long calls get closer and closer to expiration, I get more aggressive on the short calls. Effectively, I will be OUT of the long calls by expiration. I never plan to exercise these. If I’ve written several rounds of successful short calls (thereby collecting the premiums without surrendering the underlying investment), I’ll change gears.
As the long calls approach expiration, I now want these assigned.
If I’m fortunate enough to have written several rounds of short calls without getting assigned, about a week before expiration I’ll simply sell any remaining long calls outright and be done with it.
Meanwhile, if I can make 3% income on my initial capital outlay for the long-dated calls, I consider it a win. In our example, if I generate ~$1.85 total short call premiums on my initial $60.43 investment, I meet the goal.
Once all the long calls have been either assigned or sold outright, I rinse and repeat for the following year.
Please do your own careful due diligence before making any investment decision. This article is not a recommendation to buy or sell any stock. Good luck with all your 2019 investments.