Stock Market: How to Generate Cash Flow From Gold ETFs

In uncertain times like these, investors turn to what are known as “safe haven” assets. These include cash, government bonds, and gold.

The problem for income-oriented investors is that none of these offer any appreciable cash flow. Interest rates on deposit accounts are negligible, except at a few small financial institutions. Ten-year federal government bonds were yielding around 0.6 per cent at the time of writing. Gold, if held in the form of bars or coins, pays nothing.

Some gold stocks do pay dividends, but they won’t excite you. Franco-Nevada (TSX, NYSE: FNV), which I own, pays a quarterly dividend of US$0.25 per share (US$1 per year) to yield 0.78 per cent. Agnico Eagle Mines (TSX, NYSE: AEM) has a quarterly payout of US$0.20 a share to yield 1.35 per cent. Neither of those are going to pay for the groceries.

But now there is a way to own some gold and get income as well. Two Canadian ETFs are using covered call writing on gold stocks to generate cash flow, which is somewhat akin to eating your cake and having it too.

Here are the details. Prices are as of July 3.

CI First Asset Gold+ Giants Covered Call ETF (TSX: CGXF)

Type: Exchange-traded fund

Current price: $14.27

Annual payout: $0.967 (trailing 12 months)

Yield: 6.8 per cent

Risk Rating: Higher risk

Website: www.firstasset.com

The security: This ETF invests in an equal-weight portfolio of the 15 largest gold and precious metals companies by market cap listed on North American stock exchanges that have liquid options markets. Holdings include B2Gold, Yamana Gold, Kinross Gold, Gold Fields Ltd., Pan American Silver, and Barrick Gold.

Strategy: The portfolio is always fully invested. The managers write covered call options on 25 per cent of the positions to generate cash flow.

Performance: This used to be the Canadian Materials Covered Call ETF. The mandate was changed to gold and precious metals last July, so earlier returns are meaningless. The year-to-date total return is 15.65 per cent.

Key metrics: The fund has about $196 million in assets under management. The management fee is 0.65 per cent, while the management expense ratio (MER) is 0.74 per cent.

Risks: The market price depends to a large extent on the price of gold. If it rises, so will the unit price. If gold declines, so will this fund. The covered call policy places a lid on the upside potential of 25 per cent of the portfolio.

Distribution policy: Payments are made quarterly and may vary considerably. The March distribution was just over $0.32 per unit.

Tax implications: In 2019, almost all of the distribution was classified as return of capital. That means the payments were not taxable in the year received but the cost base needs to be adjusted accordingly. This tax treatment means the ETF is suitable for non-registered accounts.

Who it’s for: This fund is suitable for investors who can tolerate higher risk and want some exposure to gold along with good cash flow.

How to buy: The units trade on the TSX, with an average daily volume of about 13,500. You should have no problem being filled.

Horizons Enhanced Income Gold Producers ETF (TSX: HEP)

Type: Exchange-traded fund

Current price: $34.82

Annual payout: $1.715 (trailing 12 months)

Yield: 4.9 per cent

Risk Rating: Higher risk

Website: www.horizonsetfs.com

The security: This ETF also invests in a portfolio of precious metals stocks, but it goes beyond North America to include companies in South Africa and Burkina Faso. Not surprisingly, many of the holdings are the same as in the First Asset Fund.

Strategy: Covered call options are used to generate additional cash flow. However, in this case the managers generally write options on 100 per cent of the positions, although this can vary based on market volatility.

Performance: Over the five years to June 30, the fund generated an average annual compound rate of return of 17.2 per cent. Year-to-date total return is 20.9 per cent.

Key metrics: The fund was launched in April 2011 and has net assets of about $109 million. The management fee is 0.65 per cent and the MER is 0.84 per cent.

Risks: Here again, the value of the fund will rise or fall with the price of gold.

Distribution policy: The ETF makes monthly payments that have lately been running in the $0.18-$0.20 range. They can vary significantly.

Tax implications: The entire 2019 payout was treated as return of capital.

Who it’s for: As with the First Asset entry, this ETF is suited to more aggressive investors.

How to buy: The units trade on the TSX, with an average daily volume of about 19,600.

Summing up: These ETFs have a similar mandate. The Horizons entry has a longer track record and has performed very well over the past five years. It is more aggressive in its call writing policy.

The First Asset fund has a superior trailing 12-month yield, is quite a bit larger, and is slightly less expensive.

The funds are similar in terms of recent performance.

If you want to hold gold without sacrificing cash flow, either fund would be a good choice. But remember the risk factor if the gold price falls. These ETFs are for aggressive investors.

Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca/subscribe

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