Revamp Your Portfolio By Adding Commodity-Linked Dividend Stocks
by | Posted 7.30.2012 | Post Comment (No Comments)

One of the continual challenges of holding a solid, long term dividend portfolio is to not only have stocks that can constantly increase their payouts over time but also have stocks that are diversified to ensure that if things do go wrong, the impact will remain limited to only part of the portfolio. I’ve already discussed the importance of:

-Reaching industry diversification
-International diversification

Another interesting way to diversify is to hold stocks that decide on their payout in different ways. One of the latest trends is for some dividend stocks to pay their dividend not necessarily based on their cash reserves but rather on the prices of the commodities that they work with.

It’s A Win-Win!!

The fact is that such a policy works out well both for the company paying out the dividend but also you and I receiving the dividend.

How It Works

It’s quite simple, a company that holds gold reserves has a business that is very much linked to gold. No matter what the price of gold, the costs of exploiting it are almost identical. The revenues on the other hand are very variable and depend on the prices it can sell its gold a great deal. Thus, it makes a lot of sense for the company to make the following deal:

For Commodity Producers

-When gold prices increase by 5-10%, we will also increase our dividend to you by that percentage. We will have extra money so it makes sense to pay it out to shareholders. We will also appreciate the flexibility of paying less if ever prices did end up declining.

For Shareholders

-If one of our goals is to not only maximize our dividends but also get diversification, this is a rather unique way of getting it done. Does the dividend become a bit less stable? Yes, but as I’ve written about in the past (especially concerning stocks that pay annual dividends or in my criticism of dividend aristocrats), it’s not always about stability. It’s about making sure that the portfolio will increase dividend payouts by a strong percentage every year.

Who Does This?

This is fairly new so there are only a few companies that currently operate this way. I do expect this to change though and would be very happy to see an oil producer go ahead. In the meantime, we have:

Gold-Linked Dividend: Newmont (NEM): CEO Richard O’Brien said the policy was sustainable in the long term and that “it helps to enforce discipline in the company’s “capital spending and other spending requirements to ensure that we can keep the balance.”

Eldorado (EGO) has also done the same

Hecla Mining Company (HL) pays a dividend linked to the price of silver. Its dividend remains low but hopefully it will rise enough to become a decent play

What are your thoughts on commodity linked dividends? Do you intend to hold such a stock in the near future?