March 02, 2015 - 6:01am EST by
2015 2016
Price: 12.36 EPS 0 0
Shares Out. (in M): 254 P/E 0 0
Market Cap (in $M): 3,144 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 3,144 TEV/EBIT 0 0

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  • Canada
  • Gold
  • Closed-end Fund
  • Precious Metals
  • Discount to NAV
  • Activism


Last November I recommended going long Central Gold Trust (GTU), a
closed end fund holding just physical gold, then selling at a record high
11% discount to its NAV, or as an alternative, going long GTU and
hedging by shorting an equivalent amount of GLD, an ETF that always
trades right around its NAV.
I was thinking then of also writing up Central Fund of Canada (CEF),
similar to GTU and run by the same management, but older and larger,
with a roughly 62/38 mix of gold and silver bullion as its assets. It also was
selling at a relatively high discount to NAV then, but I had a couple other
ideas for possible VIC write-ups that werent so similar.
Time has moved on, my VIC anniversary date draws near, and even
though the discount from NAV is lower than before (~6%), I now like CEF
better, hedged or unhedged, than the other ideas. One reason is that a
Canadian activist investor, Polar Securities, has begun a campaign for CEFs
two stablemates, GTU and Silver Bullion Trust (SBT-U CN), to allow
redemptions at NAV like an ETF. If that succeeds, CEF is clearly the next
So this idea is either a hedge of long CEF short 61.5% GLD and 38.5%
iShares Silver Trust (SLV), the latter two being ETFs that always trade
close to NAV, with the idea of CEFs discount diminishing over time. Or, I
can make a case that the bear market in gold and silver have either ended
or is getting close to that point, and being just long CEF is a good gamble
here too.
Description: CEF owns 1,694,644 ounces of gold and 76,964,103 ounces
of silver, almost entirely in physical bullion form as opposed to certificates
from counterparties. I believe that when CEF was formed in the 1960s, and
with subsequent capital raises (which it did quite a few times when it was
selling at a 10% or so premium over NAV) the money is spent in a way
that brings the value of gold and silver components of the portfolio closer
to 50/50. In recent years silver has underperformed gold, so as of Fridays
close gold makes up 61.5% of the asset value.
Although it is a useful vehicle for anyone who wants to play an expected
price move in silver and gold, the fund was designed for those who would
love to store large amounts of gold and silver in their basement, but who
do not want to deal with the risk of theft, the expense of assays and
insurance, and the necessity of alarms and guns to protect their stash.
CEF lists these safeguards:
Central Funds bullion is stored on an allocated and fully segregated basis
in underground vaults located in Canada which are controlled by its
Custodian, the Canadian Imperial Bank of Commerce (the Bank), one of
the major Canadian banks.
The Bank may only release any portion of Central Funds physical bullion
holdings upon receipt of an authorizing resolution of Central Fund's Board
of Directors.
Bullion holdings and Bank vault security are inspected twice annually by
Directors and/or Officers of Central Fund. On every occasion, inspections
are required to be performed in the presence of both Central Fund's
external auditors and Bank personnel.
There are reasons why closed end funds usually sell at discounts, but most
dont apply here. Liquidity of the underlying assets are not an issue; while
$2.1B worth of gold and $1.2B worth of silver are large amounts, the
markets are usually deep enough that they could all be sold in a few days
without too much impact on the prices of gold and silver. We know what
the underlying assets are and always will be, so one doesnt have to worry
that the manager will sell good investments and use the money to buy bad
ones, which is sometimes a worry in other closed end funds. Expenses are
very low at 0.32% annually of assets as of the most recent quarter, well
below most closed end funds.
History: CEF was formed in 1961. I dont know when it went public, but
Bloomberg price history goes back to 1986. Up until 2002 CEF bounced
back and forth between selling for a premium and a discount to NAV. The
premiums got highest near market tops of gold and silver, and the
discounts got deepest at market bottoms.
From 2002 to the end of 2012, i.e., from about a year and a half after the
start of the great bull market in precious metals that ended in the spring of
2011, to a year an a half after its end, CEF always sold at a premium.
Why would a closed end fund ever sell at a 10% premium, when one can
buy ETFs or open end funds holding the very same assets at very close to
NAV? Closed end funds have a tax advantage over commodity ETFs. For
reasons that I lack the legal training or interest to pursue, a closed end
fund is considered by the IRS to be similar to that of any stock, such that if
one sells it for a profit after holding it for more than a year, taxes are at
capital gains rates, currently at 20% federal. ETFs like GLD are considered
an investment in collectiblesin which long term gains are taxed federally
at 28%. (The one proviso is that you have to fill out something called an
IRS form 8621 to take advantage of that; please do not listen to me on this
- check with your tax advisor.)
So at market tops people are optimistic, they expect capital gains, so they
are willing to pay more than NAV when there are cheaper alternatives,
because they want to save on taxes when they take their gains. At market
bottoms people are pessimistic and have no hope of long term gains, so
that premium disappears, and then some.
One to three times a year from 2006 to 2011, when its premium got in the
10% range, CEF had additional stock offerings, bought dealsas they call
them in Canada, at a discount from the then current stock price but still a
premium to NAV. That had the effect of increasing NAV and expanding
assets, the latter increasing the total fees to the trust advisor but, since it
is paid on a sliding scale, reducing the fees as a percentage of NAV.
That is win-win for both the trust unit holders and the advisors, but when
the big premium turns to discounts, as they have recently, it isnt surprising
that a large shareholder who wants to unload would rather get NAV than a
big discount to NAV, and would like the trust to make changes to allow
Choices: The safest way to make money is to go long CEF and short
61.5% GLD and 38.5% SLV. You will earn 6%, the current discount, over
whatever time period it takes for the discount to be removed, at close to
no risk. The discount has been greater than that, as recently as last
November during tax selling season when gold and silver were at lower
prices than today. With the rise of an activist investor at the other two
closed end funds run by this advisor, getting verbal support so far from the
largest shareholder of one of them, the bulls eye on CEFs back is coming
into focus.
So I dont know that one will have a chance to buy the stock at much more
of a discount than is the case today any time soon. From about 1994 the
discounts have rarely spiked to 10% and only then at decent bottoms, as
was the case in 2000 very near the absolute bottom of a bull market that
moved CEF up close to ten times by 2011.
For the longest history of CEFprice relative to NAV, use the NAV function
on Bloomberg and change the start date to 4/3/86, where the data start.
At some point the discount will disappear, and you will be able to close out
both sides of the hedge at a net profit. 6% isnt exciting, but if it happens
in a year, either because of activist investor success or because of the
psychology of the precious metals market turning more favorable, that that
isnt a bad risk free return. If the stock returns to a premium over NAV, as
it was for many years on end until two years ago, then so much the better.
CEFs premium/discount is reported in the late afternoon every market day
at http://www.centralfund.com/Nav%20Form.htm
The other approach is to consider CEF as a long only. It is easy to find
extensive commentary both bullish and bearish on the prospects for gold
over different time periods. I wont waste much space here on those
arguments. Ill just point out that the premium or discount compared to
NAV that CEF sells for, since it is a good measure of the bullish or bearish
sentiment in the gold market, has proven to be a reasonably good
predictor of which way gold is going next.
Anything can happen. Maybe gold will go down for many years and bottom
out much lower than current prices. Nothing can be ruled out. But if gold
and silver are close to a bottom here, and about to embark on a bull market
taking it back to its previous highs or beyond, one could look back a few
years from now at the discount that CEF had, both in terms of the size of
the discount and the extended length of time that it traded at discounts, and
conclude that the bottom in late 2014 should have been obvious at the
A newish factor that never existed until recently is the increasingly
widespread imposition of negative interest rates by the (clueless, IMO)
central banks. That could make holding gold and silver an attractive
alternative to losing money in cash; all that it would take for that viewpoint
to spread is for their prices to start heading higher, since price action
counts more for most people than any monetary theory.
Silver Prices: I think people are well exposed to the arguments pro and
con about gold prices, but silver is a little more complicated, involving
different factors. Since it makes up a significant part of CEFs assets, I
should discuss what affects its pricing.
There are two ways to look at silver prices. One is to assume that silver is
the poor man's gold, and will go up and down with gold, only with more
volatility. Over the decades and centuries the ratio of silver and gold prices
can make big swings, from gold selling for roughly 15 times silver in ancient
times through the early 20th century, to the 73 times silver that gold now
sells for today. For any given year, however, the correlation between their
price movements is high.
The second way is to actually analyze supply and demand. Unlike gold,
where industrial and jewelry demand is trivial compared to the stock of gold
in existence, and the output of all mines is equally inconsequential, silver
has many applications in a range of products, and the output of mines does
make a difference in overall supply and demand. Gold is always worth
retrieving and reusing, so other than perhaps wedding rings that slip down
drains and disappear in the sewer system, most of the gold ever mined has
been recovered from its original use and is reused or sitting in a gold bar or
coin somewhere. Silver, not as valuable, is often not worth trying to
recycle, especially when used in microscopic quantities as it often is.
You'll find many complications and surprises with silver, such as the fact
that even though, unlike gold, most of the demand for it is for industrial
applications, a slowing economy can actually be bullish for silver prices,
because most of the supply of silver isn't from pure silver mines, but comes
as a byproduct of mining other industrial metals, especially
copper. Anything that affects copper production, such as economic
strength or weakness, affects silver supply.
Life is short, I prefer the first approach: If gold goes up, silver will
too. Investment (or speculative if you prefer) demand and supply for silver
are what have the biggest impact on prices, because by comparison
industrial demand and supply are relatively stable. If you do want to delve
into the details of supply and demand, this outfit has
it: https://www.silverinstitute.org/site/


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.


Reduction or elimination of discount to NAV due to activist investor action; possible bull market in gold and silver

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