When To Consider The Credit Suisse Gold Shares Covered Call ETN

in focus spotlightAlthough the strength in domestic U.S. equities have primarily been held responsible for the weakness in gold, the fact remains that there are not many catalysts that hint towards a massive surge for the yellow metal in the near term.

Actually, with consideration to the present scenario, the optimism and excitement in the equity markets make for moreenticing play than the safety offered by gold. Furthermore, with the monetary base of the economy expanding at a solid clip (along with the Fed balance sheet), inflation is also expected to remain subdued in the near term.

Unless, of course, the ‘reserve’ money is actually circulated in the economy as a measure that will continue supporting the economy even after implementing an exit strategy of the monetary easing by the Fed.

And clearly, the exit strategy of the Fed isn’t taking shape anytime soon. Therefore, the hedge against inflation play for the precious metal could also be unappealing, at least in the near term (see Long-Term Treasury Bond ETF Investing 101).

These factors coupled with the dearth of investment avenues providing big yields have made a hunt for income the focus for many investors. This fact makes the investment case for gold extremely unattractive, as the yellow metal does not provide investors any current income payout.

Thankfully for income investors, the Credit Suisse Gold Shares Covered Call ETN (NASDAQ:GLDI) was recently launched this year which goes beyond convention and focuses on providing current income to investors with a subsequent exposure to gold. It basically does a Covered Call strategy on the shares of the SPDR Gold ETF (NYSEARCA:GLD) while maintaining a notional long position in the underlying ETF.

The strategy enables the fund to earn a premium on the underlying long exposure, which is distributed to holders of the ETN in the form of dividends on a monthly basis. We had earlier written an article on GLDI (see Gold ETFs Meet Covered Calls in Brand New GLDI) which explains in detail the investment strategy employed by the ETN.

Comparative Performance and Suitability

With just a tad more than a couple of months since inception, it is too early to say anything definitive about the product’s performance. Still, given its investment strategy and performance till date, there are certain things that investors must know before they are swayed by the one-of-a-kind scenario of a lucrative income opportunity along with gold exposure wrapped in a single product.

The following chart shows the comparative performance of GLDI versus GLD since the inception of the covered call ETN back in late January 2013.

As we can see theproducts are highly correlated. In fact, GLDI has a 97.14% correlation with its counterpart GLD. This is not entirely surprising considering that GLDI is itself derived from GLD. However, what is most striking is the fact that most of the time GLDI is ahead of GLD in terms of total returns. Naturally, the difference lies in the yields offered between the two (seeGold Mining ETF Slump Continues).

It is true that the yellow metal has been losing its shine in the past few months. This explains why the cumulative total returns for both these products are in the red. However, the following chart will explain another very important attribute of this product which investors should know before taking exposure to this product.

The chart above shows the difference between the daily cumulative returns of the two products (i.e. GLDI returns less GLD returns). The time frame in consideration begins at the inception of GLDI.

The chart also testifies our point from the earlier paragraph about GLDI being ahead of GLD most of the time as indicated by the curve which remains higher than 0% most of the time.

Also, if we compare chart 1 and 2, we find that the returns differential and the price of gold have an inverse relationship. This means that the return differential increases when the cumulative returns fall (in other words the price of gold falls).

Strategy in Focus

Actually, the covered call strategy involves a short term bearish outlook on the underlying asset which is probably used as a protection against a dip in prices. And at the same time, enjoy a yield on the investment received by writing (selling) slightly out of the money call options.

Furthermore, the upside for this strategy is significantly capped in case the underlying asset soars in value. This happens when the underlying asset increases more than the strike price of the call option in play (see Is the Tech ETF Signaling Trouble Ahead?).

In such an event, the buyer of the call option would exercise his right to buy from the seller at that price that was originally agreed upon (i.e. the strike price). So, even if the underlying asset soars in value, the seller of the call option (in this case GLDI) would only receive the amount which was originally agreed upon.

Therefore we see that investing in GLDI instead of GLD involves a short term bearish outlook on gold. Investors having a bullish outlook on gold are much better off playing GLD as opposed to GLDI.

Other Attributes in Focus

Investors should also be aware that the structure of GLDI is that of an exchange traded note (ETN). Therefore it would be subject to credit risk of the underlying issuer. However, the structure also means that the note will not be subject to tracking error, an important consideration.

Additionally, the exposure for GLDI doesn’t come cheap as the expense ratio of 65 basis points will no doubt dent investor pockets. Especially when compared to its other low cost peers.

However, considering its current market price of $19.12 at the time of writing coupled with its distribution thus far, we get an average annual yield of 5.87% for GLDI. This is a pretty impressive yield indeed. But don’t be swayed away by just the yield factor alone– instead, give more thought to the near term outlook for the yellow metal when deciding between the two for a short-term trade.

This article is brought to you courtesy of Eric Dutram From Zacks.

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