Income investors are exposed.
The U.S. government has racked up $10 trillion in debt and Washington continues to spend more money we don't have. No one's talking about balancing the budget: The Obama Administration estimates budget deficits will soar to $1.8 trillion this year and $1.3 trillion in 2010.
Many think the value of the dollar will undergo an epic plunge. That may have begun: The dollar has fallen about -15% versus other major currencies since March. And Washington just keeps printing more money. So far the federal government has lent, spent or contributed trillions of greenbacks in stimulus and bailouts.
As the economy recovers, more private dollars will combine with the federal dollars and the flood of money will cause inflation. The Federal Reserve, to combat rising prices, will likely be forced to increase interest rates in response.
So, what's the problem?
The economy is still in the tank. My fixed-rate investments are doing great. Buying bonds and preferred stock was the best thing I ever did.
The problem is that fixed-rate investments love recessions but hate inflation. Inflation and rising interest rates cause the value of bonds and other fixed-rate investments to plummet along with the purchasing power of the dollar.
Now, one can hope this scenario won't unfold. But it's only prudent to prepare for the possibility. I found an investment that can help protect your portfolio from inflation and pay you 10% at the same time.
The Gabelli Global Gold, Natural Resources and Income Trust (NYSE: GGN) is a closed-end fund that pays a high monthly distribution. It invests at least 80% of its assets in stock in companies in the gold and natural resources industries.
As of June 30, the fund held most assets in metals and mining (54.8%) and energy and energy services (35.9%). Top holdings included gold mining giant Newmont Mining (NYSE: NEM), massive copper producer Freeport-McMoRan (NYSE: FCX) and Brazilian oil and gas producer Petroleo Brasileiro (NYSE: PBR).
What's so great about gold, metals and oil?
They're commodities. Commodities -- real things -- are hard assets. They tend to appreciate in times of inflation as investors put their money in assets that have intrinsic value.
When inflation hits, the businesses that produce such commodities tend to thrive. For instance, when the Consumer Price Index rose from 3% in May 1972 to 11% in December 1974, the S&P Goldman Sachs Commodity Index rose +222%, averaging +55% annually.
Bonds -- a fixed-income investment -- only averaged a +5% gain.
During the high inflation/high interest-rate period of 1972-1981, commodities returned an average +19.2% a year while bonds averaged just +3.3%. After taxes and inflation, the bond return was actually negative.
In addition, supply and demand factors bode well for commodities as we go forward. The world continues to consume 80 million barrels of oil a day. The emergence of China and other developing markets will make demand for industrial raw materials soar to levels never seen before.
While there are many ways to invest in commodities and other commodity funds, the great thing about the Gabelli Gold, Natural Resources and Income fund is the revenue stream. The fund has consistently paid a dividend of $0.14 every month since its inception in March 2005. That equates to an eye-popping 10.3% yield.
The fund pays dividends from writing covered calls. Writing calls involves selling someone the right to buy your security at a certain price; if the security doesn't reach that price, the seller of the option gets to keep the money he was paid for the option. It's a good way to generate income, and the only downside is selling a rising stock that might rise more.
The fund's annualized total return since inception is +4.1%. The S&P 500 is negative for the same period. GGN, however, has returned more than +37% year-to-date.
There is a strong chance that inflation rears its ugly head in the not-too-distant future. It could be next week or it could be several years. GGN offers investors income in the meantime. Make sure you have something in your portfolio that will perform well in inflationary times.