ASA - ASA Gold and Precious Metals: Add Gold To Your Portfolio As A Hedge Against Financial Stress

2023-10-11 08:22:32 ET

Summary

• ASA Gold and Precious Metals Limited is a closed-end fund that focuses on investing in gold miners and precious metals mining companies.
• The fund's yield is much lower than that of most closed-end funds, at only 0.15%.
• Gold has not been performing well in the current high interest-rate environment, but the fund could still be a good way to hedge against the financial condition of the US government.
• It seems quite likely that gold will appreciate going forward, and this fund acts as something of a leveraged play on gold prices.
• ASA generated some capital gains during the most recent reporting period, but it is still down over the past eighteen months. It is currently trading at a discount on NAV.

ASA Gold and Precious Metals Limited ( ASA ) is a closed-end fund that focuses on investing in gold miners, precious metals mining companies, and similar companies. Unlike most closed-end funds, however, this one is not an American company, so it does not have to comply with American rules regarding the distribution of investment profits. As a result, its yield is much lower than that of most closed-end funds. As of the time of writing, the fund only has a 0.15% yield. As such, this is one of the few closed-end funds that will deliver the majority of its investment returns in the form of share price appreciation rather than distributions paid to investors. This is something that some people might appreciate given that it is much more tax-friendly than distribution, although it is not nearly as appealing for those investors who are seeking to earn a high level of income.

As many people reading this are likely aware, gold has not been performing especially well in the current high interest-rate environment. This is mostly because market participants prefer the 5% yield that can be obtained by simply stashing cash in a money market fund as opposed to gold, which has no yield. As such, this fund has not delivered a particularly impressive performance. Over the past year, it has been almost perfectly flat, which is substantially worse than the 20.65% return that the S&P 500 Index ( SP500 ) has delivered over the same period:

However, there could still be some reasons to invest in gold, as the financial condition of the United States government is not particularly good, and it is very difficult to see how it will be able to continue on its current trajectory without quantitative easing and money printing returning as the dominant monetary policy at some point. While the Federal Reserve is currently committed to its inflation-fighting stance, the political pressures will eventually force it to choose between two disparate positions. That will almost certainly prove to be a good thing for gold. As such, it may be a good idea to include gold in your portfolio as a hedge against this political dynamic. This fund could be a good way to do that.

As regular readers may recall, we last discussed this fund around the end of April. Naturally, there have been numerous changes in the market environment since that time. In particular, the optimism of a rapid pivot by the Federal Reserve has been replaced with one of resignation that high interest rates may be with us for a while. For its part, the fund has performed quite poorly since that time, as its shares have dropped by 20.88% over the period. This is quite a bit worse than Gold ( GLD ) itself, which has only declined by 6.20%, and it is certainly worse than the positive return of the S&P 500 Index over the same period:

This is a very vast performance difference that we should investigate before deciding if this fund could be a good way to add gold to your portfolio today. This article will endeavor to do exactly that.

About The Fund

According to the fund's website , ASA Gold and Precious Metals Limited has the primary objective of seeking long-term capital appreciation. As the name of the fund implies, it seeks to do this by investing in companies that will benefit from appreciation in gold prices. The website explains the strategy thusly:

The Company is a non-diversified, closed-end fund that seeks long-term capital appreciation primarily through investing in companies engaged in the exploration for, development of projects or mining of precious metals and minerals.

It is a fundamental policy of the Company that at least 80% of its total assets must be (i) invested in common shares or securities convertible into common shares of companies engaged, directly or indirectly, in the exploration, mining or processing of gold, silver, platinum, diamonds or other precious metals, (ii) held as bullion or other direct forms of gold, silver, platinum or other precious minerals, (iii) invested in instruments representing interests in gold, silver, platinum or other precious minerals such as certificates of deposit therefor, and/or (iv) invested in securities of investment companies, including exchange traded funds, or other securities that seek to replicate the price movement of gold, silver, or platinum bullion.

This is an interesting description as it implies that the fund will hold essentially no cash. Its "money," as gold bugs would define "money," is primarily going to be in bullion. With that said though, the fund does have 1.86% of its portfolio invested in cash with the rest invested in common or preferred stock:

As we can see from the description, the fund wants to be invested primarily in things that track the price of gold, or in gold directly. Unfortunately, its shares fail to do that perfectly. As we can see here, the SPDR Gold Shares, an exchange-traded fund that claims to track the price of gold, is up 52.84% over the past five years. Meanwhile, ASA Gold and Precious Metals Limited is up 49.38% over the same period:

The fund has been considerably more volatile than the price of gold over the period, which is both a good and a bad thing. We can see that it did deliver much better returns than gold did over a good portion of the period, but its performance started to deteriorate once the central bank started to raise interest rates. This could be due to the fund's focus on investing in precious metals mining companies, as opposed to the metal itself. The most recent fact sheet states that 55.8% of the fund is invested in miners, with substantial holdings in other companies across the value chain:

According to Invesco's John Corcoran :

Gold and precious metals equities have historically outperformed the price of gold by twofold to threefold when both bullion and precious metals mining stocks are rising.

Thus, in some ways, the fund can be thought of as a leveraged bet on gold prices. It should outperform gold when gold prices are rising, but the reverse is also true. This actually explains much of the fund's volatility relative to gold bullion itself.

One thing that readers may note is that the fund's description on the webpage states that it invests in precious metals other than gold. Thus, gold prices are not the only precious metal whose price we need to be concerned about when it comes to this fund. However, gold is by far the most important component of the fund's performance. The fact sheet itself states that 80.8% of the fund's assets are invested in things that will directly benefit from rising gold prices:

The actual importance here of gold prices is probably even more important due to the fact that diversified miners will also probably be mining gold to a certain extent. Thus, the fund should work quite well as a way to play gold prices, which works pretty well with our overall thesis.

Gold Price Fundamentals

At this point, some readers might be asking why anyone should consider investing in gold. After all, gold has become somewhat out of favor ever since the Federal Reserve started raising interest rates. In fact, this can be said of just about all assets with no actual yield. After all, when it is possible to get 5% just by leaving your cash in a money market fund, it does not make a lot of sense to purchase gold, which by its very nature has no yield. While there are some common stocks that have no dividends that have held up reasonably well in the current environment, the issuing company has free cash flow, so it still produces some wealth. Gold, meanwhile, is simply a store of wealth that produces nothing. At least, this is the common argument against gold in a high-interest rate environment.

However, gold has held up reasonably well over the past twenty months or so. This chart shows the spot gold price against the S&P 500 Index since January 3, 2022 (the first trading day of 2022):

On this chart, gold is represented by the black line and the S&P 500 Index by the blue line. As we can see, gold actually outperformed the S&P 500 Index over the period, albeit not by very much. Gold has also rebounded fairly substantially since the start of this year, but as was the case with the index, it started to lose some of its shine when the market woke up to the very strong possibility that the central bank will not be cutting interest rates in the near future. The point though is that gold has performed better in the current market than the media would have one believe.

The real case for gold though can be found by looking at the federal government's very disturbing budget projections. Over the past twenty days, the national debt has increased by $500 billion. As Michael Maharrey points out at Schiff Gold, the United States' national debt hit $33 trillion on September 15, 2023. On October 5, 2023, it hit $33.5 trillion. That is an increase of $500 billion in just twenty days. This represents the continuation of a long-term trend, however:

The United States federal government has now added $1.5 trillion to the national debt since June 1, 2023. If this is happening in a supposedly strong economy, it should be incredibly concerning what will happen during the next recession.

During the first eleven months of fiscal year 2023, the United States federal government spent $630 billion on interest payments on the national debt at an average interest rate of 2.92%. As of right now, the ten-year Treasury sits at 4.657% so we can quickly see that its interest expenses will increase rapidly as it has to start rolling over this debt. If the government is already struggling to carry its debt, which it certainly appears to be (or else there would not be a deficit), it is difficult to see a way that it will be able to carry substantially higher interest expenses.

This is just the beginning of the problem. As I pointed out in a recent article , the Congressional Budget Office projects that the national debt will reach 181% of the nation's gross domestic product by 2050. That is, of course, assuming that there will be no recessions that drive up social safety net spending and static interest rates. The agency also projects that the annual deficit will increase from $1.5 trillion today to $2.5 trillion by 2033. It does not seem particularly likely that the national gross domestic product will be able to grow at a sufficient rate to cover this increasing debt. On average, the United States' gross domestic product grew by an average of 2.25% annually under George W. Bush, 1.59% annually under Barack Obama, and 1.03% annually under Trump. Thus, it appears that the growth rate has been steadily declining over the course of the 21st Century so far. This is in line with a World Bank study that found that a nation's gross domestic product growth slows as a nation's national debt gets higher. Thus, it seems quite unlikely that the country can grow its way out of this problem.

This puts the Federal Reserve in a very tight position. This is because it basically has two options:

• Keep interest rates high and force the United States Government into a possible default. It is difficult to know what the effects of this will actually be but considering the importance of Treasury securities to the global financial system, it would almost certainly result in a financial crisis far worse than the one that occurred back in 2007/2008.
• Accept inflation and begin monetizing the debt. It is almost certain that politicians will be pushing for this solution so that they can continue spending money.

Either of these options will probably be good for gold, so realistically it is probably a good idea to hold some exposure to it in your portfolio as a hedge against whatever may be coming down the pike.

Distribution Analysis

One of the primary reasons why investors purchase closed-end funds is because of the high distributions that they pay out. As mentioned earlier in this article though, ASA Gold and Precious Metals Limited is very different. This fund does not attempt to maintain a static net asset value while paying out all of its distributions to the shareholders, which is the modus operandi of most other closed-end funds. Rather, this one seeks to grow its net asset value and have its own shares appreciated as a result. That is generally the way that most exchange-traded funds work, but this is not an exchange-traded fund because it has no sponsor that is always available to create and redeem shares. The fact that this fund simply tries to have its own shares appreciated works pretty well for investors buying the fund in taxable accounts, so that could appeal to some potential investors.

ASA Gold and Precious Metals Limited only pays a nominal distribution of $0.01 per share every six months ($0.02 per share annually), which gives the fund a 0.15% yield at the current price. However, it has been known to occasionally pay out special dividends:

For the most part, though, we can see that the fund tends to pay out about as small of a distribution as it can get away with. Thus, this is certainly not a fund for people who are seeking to earn income to pay for their expenses. It is for people who are seeking to use gold as a hedge to protect their wealth.

We should still have a look at the fund's finances though, just to make sure that it is performing well and not bleeding money unnecessarily. After all, it will not be able to protect our wealth very well if it is not keeping it invested as it promises.

As of the time of writing, the fund's most recent financial report corresponds to the six-month period that ended on May 31, 2023. This is a newer report than the one that we had the last time that we discussed this fund, which is quite nice as it will give us a more current picture of the fund's finances. As we saw earlier in this article, gold prices were quite strong during the first half of this year, so the fund may have had the opportunity to earn some capital gains during the period of time that is covered by this report. Naturally, we will want to have a look and see how much success the fund had during the period.

During the six-month period, ASA Gold and Precious Metals Limited received $1,058,619 in dividends and $13,944 in interest from the assets in its portfolio. This gave the fund a total investment income of $1,072,563 during the period. This was not enough to cover its expenses, and the fund reported a net investment loss of $719,473 over the course of six months. This is admittedly concerning but given the low-yield nature of gold and many gold miners, it is not really surprising.

Fortunately, the fund has other methods that can be used to provide a return to its investors. For example, it specifically states in its objectives that the generation of long-term capital gains is its primary objective. The fund did succeed in this task during the period, as it reported net realized gains of $3,718,797 and had another $18,548,191 net unrealized gains during the period. The fund only paid out $192,899 in distributions, so it obviously managed to cover both those and the net investment loss solely out of capital gains. Overall, the fund's assets increased by $21,354,616 during the period after accounting for all inflows and outflows.

The fact that the fund's assets increased during the period is certainly nice, but it follows a year in which the fund's net assets went down by $156,325,826. Thus, the fund's net assets are still down over the past eighteen months. We can still see that it is doing a far better job at earning money than the distribution might make one think, though.

Valuation

As of October 10, 2023, ASA Gold and Precious Metals Limited has a net asset value of $15.59 per share. However, the shares currently trade for $13.23 each. This gives the fund's shares a 15.14% discount on net asset value. This is, to put it mildly, a very large discount and a very acceptable price to pay for the fund. As I have pointed out in numerous previous articles, a double-digit discount on net asset value generally represents a good entry point for any closed-end fund.

Conclusion

In conclusion, ASA Gold and Precious Metals Limited is a somewhat unconventional closed-end fund that provides a way for investors to add gold and other precious metals to their portfolios. Admittedly, gold has not been a great asset over the past several months, as rising interest rates have caused investors to dump it in favor of things that pay a current yield. However, the deteriorating financial condition of the United States government essentially makes the case for gold as it seems almost certain that we are heading into a period of financial upheaval and systematic stress.

For further details see: