If you are invested in the precious metals sector then you most likely already know about SPDR Gold Trust (GLD) and iShares Silver (SLV). The purpose of this article is to present the advantages of investing in precious metals closed-end ETFs over GLD and SLV.
For those that don't know, a closed-end ETF can trade at a premium or discount to net-asset-value at any given time. The five closed-end ETFs I will discuss are Central Fund of Canada (CEF), Central GoldTrust (GTU), Sprott Physical Gold Trust (PHYS), Sprott Physical Silver Trust (PSLV), and Sprott Physical Platinum and Palladium (SPPP).
What are the advantages of precious metals closed-end ETFs?
- They have low annual fees. For example, the annual fee for CEF is 0.3%.
- They are taxed at the long-term capital gains rate. SLV and GLD are supposed to be considered "collectibles" and taxed higher.
- The premiums above net asset value fluctuate, so you can take advantage of this as a trader.
What are the disadvantages?
- The trading volume is lower so there can be gaps between the bid and ask price. This is especially true for GTU.
- There are no call or put options available.
CEF's net asset value is currently about 55% gold, 44% silver, and 1% cash. It trades at a 0.6% discount below net asset value, but the average premium in the past 52 weeks is 3.4%.
GTU's net asset value is currently about 99% gold and 1% cash. It trades at a 0.4% discount below net asset value, but the average premium in the past 52 weeks is 2.7%.
PHYS' net asset value is currently about 99% gold and 1% cash. It trades at a 0.7% premium above net asset value, but the average premium in the past 52 weeks is 2.5%.
PSLV's net asset value is currently about 99% silver and 1% cash. It trades at a 0.4% premium above net asset value, but the average premium in the past 52 weeks is 3.6%.
SPPP's net asset value is currently about 48% platinum and 52% palladium. It trades at a 0.7% premium above net asset value. SPPP is a new ETF that began trading last December so it does not have a 52-week average premium.
(The net asset values were calculated based on the spot price of these metals at the end of day on April 8, 2013)
As you can see, these five closed-end ETFs are all trading at prices that are barely above their respective net assets values. In the case of GTU, it is trading at a discount. They should be trading at a higher premium based on the following reasons:
- Historically, the premiums have been higher. Compare the current premiums to the average premiums over the past year.
- Some of them like PSLV can be converted to physical bullion. So it would be illogical for them to trade at a discount to net asset value. So the downside risk should be minimal. Maybe only 1% at this point.
- You cannot buy a gold or silver bar or coin from a dealer without paying a premium. These premiums are typically around 3-4%.
So let's get to the arbitrage opportunities. It's simple to execute a pair trade to take advantage of the low premiums over net asset value. You buy one of the closed-end ETFs and short the equivalent amount of GLD and/or SLV. For SPPP, you would short ETFS Physical Platinum (PPLT) and ETFS Physical Palladium (PALL). Here's an example:
- Buy $20,000 worth of PSLV (about 1860 shares)
- Short $20,000 worth of SLV (about 760 shares)
- Wait for the premium for PSLV to rise and then close the two transactions above.
Please keep in mind that PSLV also holds cash. So if you buy $20,000 worth of PSLV you are not getting $20,000 worth of silver. You are getting about 99% of silver and 1% cash. So if you buy $20,000 worth of PSLV you are buying slightly less ounces of silver than you are shorting. If you want to make the ounces equal in weighting then you need to buy about $20,200 worth of PSLV.
The time to act on these suggested pair trades is now while the premiums are low. Downside risk is minimal because of the current low premiums. Also, because these are basically market neutral trades, there is no need to fear a collapse in gold and silver prices.
This is my first article as a contributor on SA. Feedback is welcome.