Without A Ceiling On The Fed's Balance Sheet, CEF Is A Buy
Summary
- As the Fed's balance sheet grows, the precious metal will, ultimately, account for the debt monetization.
- CEF has behaved more like silver that could be good if silver outperforms gold.
- We could see a scenario where CEF permanently trades at a premium to NAV.
There are a variety of ways to play precious metals if, like me, you think gold and silver are going much higher. In previous articles, I've given some of my equity picks that give more of a leveraged play on gold and silver. Though I don't think there is anything better than buying the physical metal and storing it yourself if you truly want exposure, as we have seen in recent weeks, finding physical metal may prove challenging and expensive. Sprott Physical Gold and Silver Trust (NYSEARCA:CEF) is the next best thing, in my opinion.
In my coverage of IMPACT Silver Corp. (OTCPK:ISVLF), I took a look at the balance sheet of the Federal Reserve and made two related points that I felt illustrated why the prices of precious metals are very likely to move much higher. The first point centered largely on just how aggressively the Fed had increased the balance sheet in a short amount of time. The second point added the gold price as an overlay to show the relationship over the last two decades between the two. That article was written in March. Let's get an updated view of those points. Below are the top ten weekly expansions by percentage. March/April 2020 deliver three of the top ten and two of the top five weeks going back 18 years.
| observation_date | Assets (millions) | Week/week Change |
| 2008-10-01 | $ 1,503,989 | 24.11% |
| 2008-09-24 | $ 1,211,825 | 21.78% |
| 2020-03-25 | $ 5,254,278 | 12.55% |
| 2008-10-15 | $ 1,770,809 | 11.26% |
| 2020-04-01 | $ 5,811,607 | 10.61% |
| 2008-10-29 | $ 1,969,086 | 9.24% |
| 2009-03-18 | $ 2,066,942 | 8.81% |
| 2020-03-18 | $ 4,668,212 | 8.26% |
| 2008-09-17 | $ 995,093 | 7.49% |
| 2008-11-12 | $ 2,212,852 | 6.68% |
(Source: FRED)
The Federal Reserve Bank has now added $2.9 trillion to the balance sheet since August. That's a staggering amount. When we add the price of gold as an overlay, we can see that gold has significant catching up to do. A gold price north of $2,200 an ounce isn't out of the question in my estimation. And that's without any additional movement up in the balance sheet.
If we accept that gold, and by extension silver, are poised to move up as the Fed monetizes debt, the next step is hypothesizing where the balance sheet is going.
We Ain't Seen Nothing Yet
Looking at the Fed balance sheet expansion is just part of the puzzle. Yes, $2.9 trillion in about eight months is an incredible visual when you just look at the expansion nominally. But when you focus on the week to week change as a percentage, 2008 was still far more extreme than what we've seen over the last month and a half.
Source: FRED, author generated graphic
Furthermore, we can see that despite massive expansion from mid-March through early-April, the growth as a week over week percentage has actually been slowing down the last three weeks. And again, the initial spike higher still doesn't sniff what the Fed did in 2008 on a week over week percentage basis. Point is, it's not enough.
What's that saying? This time it's different. Well, this time, it might actually be different. The initial claims chart says it all. 3.8 million Americans filed for unemployment last week. That puts the six-week total at just above 30 million. It really isn't a leap to suggest we're going to see a massive rise in delinquencies of credit card, auto loan, and housing payments. It's already been reported that 4.2 million mortgages are already in forbearance. We haven't seen anything like this. It's going to get ugly. And the Fed is going to continue to print to try to fix everything.
Why CEF?
CEF has performed more like silver than gold in recent years.
Source: investing.com
Despite CEF acting as a bullion trust for both gold and silver, I find it peculiar that the fund has underperformed against gold to the degree that it has because the majority of the fund is gold.
| PREVIOUS CLOSE | |
| Net Asset Value per Unit | $15.41 |
|---|---|
| Previous Closing Market Price | $15.50 |
| Premium/Discount Calculation | 0.59% |
| Units Outstanding | 202,485,218 |
| Total Ounces of Gold held within Trust | 1,324,146 |
| Total Ounces of Silver held within Trust | 59,107,912 |
| Total Market Value of Gold & Silver held within Trust | $3,118,000,095 |
| Total Net Asset Value of Trust | $3,119,992,225 |
| (In U.S. Dollars. Data last updated Thursday, April 30, 2020, 6:00 PM EST) Source: Sprott.com | |
At over 1.3 million ounces of gold and 59.1 million ounces of silver, over 71% of the fund's asset value is derived from gold. Yet, for the last seven years or so, CEF's performance has hugged silver's trajectory more than gold's. If this continues, CEF could outperform gold as long as silver does too. And there are many who believe that is precisely what is going to happen.
I would certainly not encourage anyone to buy silver or CEF purely because of the gold-silver ratio, but I do think it is something that should be considered when judging metals. The market views silver more as an industrial metal and less as a monetary metal. This is wrong, in my opinion, for two reasons. The first is that both metals have a history of acting as monetary instruments. That the gold standard was abandoned a few years after the US mint stopped making quarters with silver shouldn't matter. Both metals were money until "they weren't." Second, silver will benefit from a replacement effect. As the price makes physical gold more unattainable for the average person, silver will start shining again when it catches a bid from lower net-worth individuals.
Paying more than the NAV
While the fund has typically traded at a discount to net asset value, we're now seeing a shift to a market premium for shares.
Source: Sprott.com
I want to be very transparent on this point; in my Grayscale Bitcoin Trust (OTC:GBTC) coverage last year, I voiced my concern with the idea of holding Grayscale's trust because of that large and volatile premium. For CEF, however, there is a fundamental difference that can't be overstated. Gold and silver both physically exist in the natural world while cryptocurrencies do not. For this basic reason, I don't view paying a premium on the NAV of Sprott Physical Bullion Trust as egregious given the metal shortage and mine closures the industry has experienced in the last few weeks. If anything, I believe the premium on the net asset value is likely to move higher as physical precious metal bars and coins continue to sell at sizeable premiums above the spot on bullion sites and eBay.
Risk Factors
With the economy in recession and a consumer far less likely to make large purchases on credit, deflation could be a real headwind for the metal in the immediate future. This could keep precious metals from rising in dollar value and, by extension, CEF would likely suffer in the same way. Despite this legitimate concern, I view any deflation as being short-lived. The currency bombs aren't done yet.
Conclusion
Everything we're seeing right now is flashing big red lights. We saw how incredible the decoupling of the paper and physical silver price was last month. What we witnessed at that time was a pricing oddity thanks to a futures market that operates with questionable (at best) trustworthiness. And this was maybe just the first in a handful of unbelievable market happenings in a matter of just a few weeks. The May WTI contract traded well below $0 per barrel. As I write this, 30 million people are out of jobs. Apparently, that means buy stocks. US equities are going to do what they're going to do. Gold and silver are very likely going much higher. Despite their best efforts, the Fed was unable to cure the virus with balance sheet expansion. That won't stop them from trying again.
This article was written by
Analyst’s Disclosure: I am/we are long CEF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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