Golden Buys for Income

05/02/2003 12:00 am EST

Focus:

Mark Skousen

Editor, Forecasts & Strategies, High-Income Alert

"Expect gold to make a comeback," says Dr. Mark Skousen, editor of Forecasts & Strategies . "Gold now appears to be in an excellent buying range, particularly given that inflation is edging back up. The CPI has edged up 3% over the past year and will probably move higher due to the war on terrorism, growing deficits, and the Fed's easy money policies. Further, with the dollar showing weakness, gold should pick up, as it tends to move in the opposite direction from the dollar."

"The Freeport Copper & Gold convertibles (FCX-A, FCX-C and FCX-D ), in my judgment, are the best way to profit from gold. FCX-A is convertible to the parent company and is yielding 8.1%, paid quarterly. With FCX currently selling near $18 a share, it is unlikely that you will be converting anytime soon. But the yield is high, and the convertible has been increasing in price recently. FCX-A is a perpetual preferred, meaning that it has no maturity date. However it is callable at anytime at $25 a share.

"FCX-C, trading near $32, is a gold convertible that has doubled in value in the past year. It's been the best-performing Freeport convertible. When it matures in February 2006, Freeport agrees to convert FCX-C to 10% of the gold price in February 2006. Suppose gold's price is $400 by then. That would mean you would make 25%, plus the annual dividend of $1.07 (currently) a share. FCX-C pays a quarterly dividend of 0.0008125 times the current gold price. At $330 an ounce, that's $0.26 cents a quarter, or $1.04 a year. FCX-C has done well in the past year and will continue to do well if gold rises. FCX-C is also selling at a slight discount to 10% of the gold price (currently $325 an ounce).

"FCX-D, trading just below $9, is a silver-linked convertible preferred. It has not moved up in value much, for two reasons: It's linked to the silver price, which has not moved up as much as gold, and Freeport returns part of the principal each year (equivalent to half an ounce of silver per share). With silver at $4.50, the quarterly dividend is around 6%. Silver would have to decline to under $4 for you to lose money on this convertible preferred. The Freeport preferred D is not the highest potential silver play, but certainly has good downside protection, is leveraged to higher prices, and pays you while you wait.

What are the risks associated with Freeport gold convertibles?

1. Gold may decline in value. I don't expect gold to show much weakness in the face of economic uncertainties, war, and inflationary pressures by the Federal Reserve, but you can never be 100% sure.

2. Freeport McMoRan, the parent company, holds a high level of debt and may have to postpone the maturity date on FCX-C. However, it promises to pay off its FCX-B convertible coming due in August. It recently issued $500 million in convertible senior notes at 7% to cover the expense of redeeming FCX-B and other obligations. The parent company is making money.

3. The Freeport copper-gold mine, known as the Grasberg property, is located on a large island in Indonesia. Indonesia has suffered from financial and political instability over the past few years. Freeport has done everything it can to maintain good relations with the government, and has invested over $1 billion in infrastructure, schools, and other benefits to the Indonesians. In addition, they share 50% of the revenues with the government. It is in Indonesia's best interest to preserve this relationship, but one never knows when the government might act irrationally and nationalize Freeport. I don't think it will happen, but one must recognize the risk involved with this income investment and not commit too much to any of these investments."

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