The purpose of this article is to discuss the Sprott Physical Gold and Silver Trust (NYSEARCA:CEF) as an investment option at its current market price. This is a fund I own for most of my commodity exposure (aside from Energy funds), but I have been disappointed with its performance of late. While it started off the year strongly, CEF has struggled in the second half of 2021. In fact, it has seen a sharp drop during a time of rising markets, as illustrated by the relative returns of CEF and the S&P 500 since my June review:
Source: Seeking Alpha
With this backdrop, I wanted to re-evaluate if it continues to make sense to hold this asset, and whether I should be "buying the dip". After review, I do see potential for gains from here, so I feel adding on this weakness is a smart play. However, risks to this thesis are absolutely present, so I would tread carefully here, and do not too big, too fast. Ultimately, this push and pull leaves me with a generally neutral view on the short-term outlook for CEF, and I will examine the pros and cons of buying now in detail below.
For the first few paragraphs, I am going to examine a few key reasons why someone would want to own gold and silver, and CEF by extension, in this current climate. Clearly, the macro-trend for these assets has not been positive, but there are reasons for anticipating a broader reversal in this dynamic.
One key reason is simple - stocks are expensive. As equity prices rise, the merit to buying hedges looks more attractive for new cash. To me, it is getting harder to justify starting new stock positions now, with market indices re-claiming levels just shy of their all-time highs this past week. With weakness in funds like CEF, investors could decide to stay with the momentum equity play. Yet, there is no denying the S&P 500 is at an expensive level, in terms of price-to-earnings ratios, as shown below:
Source: Yahoo Finance
The conclusion here is straightforward. Stocks are not cheap, so hedging against downside risk in that asset class makes sense. Assets like gold and silver provide a way to do so. Further, as stocks remain in pricey territory, the attractiveness of putting new money to work there falls. If investors have cash on the sidelines, they may be looking for relative value elsewhere. With CEF dropping and offering reasonable buy-in points for traditional safe havens like gold and silver, the logic to owning some seems solid.
Of course, there is another reason for "traditional" alternative assets like gold and silver have been faltering, aside from the continued rise in equities. This has been the emergence of a whole new type of asset class - cryptocurrency - which is bringing in cash from other areas as investors look to capture this multi-year growth theme. While Bitcoin has been the name of the game for a while, many other cryptocurrencies have emerged. Investors have been using these assets as ways to hedge against equity risk, to play momentum swings, and to take advantage of the newest fad. The end result is, this money has to come from somewhere, and demand for gold and silver has likely been faltering as investors choose to store cash that would have been going to those assets in to cryptocurrencies.
For the purposes of this review, I am not suggesting investors avoid crypto. In fact, I own some Bitcoin myself. However, I want to point out that one does not have to own one or the other. There is a case for owning both asset classes, so rounding out a portfolio with metals and cryptos has merit.
To understand why, let us look at the correlation trend between popular commodities such as gold and Bitcoin. While they had been trending in-line with each other for a while, that trend broke down at the end of last year. In fact, as Bitcoin has had a strong 2021 and gold has not, the rolling correlation between the two has pushed in to negative territory:
Source: S&P Global
My point here is not that one is "better" than the other. Simply, this suggests owning both at the same time has merit. If the two were continuing to trade in the same pattern, investors could draw the conclusion that owning one is enough to balance out equity, inflation, or volatility risk. But, with the two seeing their fortunes diverge, I see a case to be made for owning the two simultaneously. It helps to keep investors from getting too concentrated in some particular hedge, and it provides a way to balance a portfolio out when one is having a bad day/week/month, and the other is not.
Another thought on CEF in particular, when considering gold and silver, is the fund's valuation. This is a fund that typically trades at a discount to NAV, and that story remains the case today. While the discount is not large, it does present some relative value in a market when most asset prices seem frothy. At time of writing, that discount is slightly above 1.5%, as shown below:
I won't go in to too much depth here because it is a straightforward metric. Ultimately, I see funds trading at a discount right now as a smart way to enter what appears to be a generally expensive market - whether we are talking about stocks, commodities, housing, or crypto. CEF, with a current discount, fits this bill.
While I have laid out a few reasons why buying in to CEF may be timely, I did mention at the onset of the review that I am generally neutral on the immediate performance. What this means is, I expect modest gains, but not out-performance necessarily. This lends merit to holding a position, in my view, because I see a fund like CEF has lowering my overall volatility when the market gets rocky. But, at the same time, there are headwinds out there for gold and silver, and therefore CEF. This balancing act is one investors need to consider if they are determining if this is the right move for them.
Bear in mind, the market has not been on the side of gold and silver right now. CEF's poor performance is a reflection of that, so we have to consider this is not a momentum play. Trends can often last a long time, so while I see some relative value here, we have to manage expectations. CEF has been struggling for a few reasons, so let us examine the why behind that performance. This will help readers better determine if they want to dive in now.
To begin with, inflation has been rising steadily, especially as 2021 has gone on. While inflation can be a positive for gold and silver, that has not been the case of late. This is likely to the acceleration of inflation metrics we have witnessed in the second half of the year. While unemployment has dropped, supply chain issues exist, and oil prices rise, the Consumer Price Index has shot higher. This has pushed this metric well above prior year levels:
Source: Charles Schwab
The takeaway here is inflation is rising, and rising fast. But, wait, readers may be asking, isn't inflation good for gold and silver?
The answer is a complicated one. It can be yes, but generally when inflation is rising at a modest clip. Commodities can generally provide a buffer against inflation and protect purchasing power, but when inflation gets too hot, that relationship breaks down. This story has been pretty clear in 2021. At the start of the year, inflation was modest and expected to normalize and, thus, gold and silver were performing relatively well. However, as 2021 progressed, inflation got more red hot, and gold and silver suffered. Therefore, we have to consider, is this the common relationship to expect?
The answer is, generally, yes. If we look at time periods of high inflation, we see gold has out-performed some times, but lagged during others:
This, of course, seems to be a time when gold is the laggard. My conclusion is thus that readers need to opine on their own outlook for inflation. If they expect it to moderate in 2022, then buying gold (and CEF) could work out well. If they expect inflation to keep on accelerating in the new year, this investment thesis is more of a gamble.
I have spent most of this review focusing on gold. However, CEF is a fund that invests in both gold and silver. In fact, the fund is pretty heavily exposed to silver, with about one-third of its assets invested in that commodity:
Clearly, as an owner of CEF, I like this exposure. But this begs the question - why?
There are a number of reasons why I prefer this exposure. One is the most obvious. It provides a diversifier. Rather than just investing in gold as a hedge, I get both gold and silver, which should limit some of the concentration risk. While silver can often be more volatile than gold, I still like this trade-off because I can two different hedges, rather than just one. Two, silver has the ability to offset some of the downsides in gold that I mentioned in the preceding paragraph. In particular, silver is considered to be more tied to the global economy, with practical uses in heavy industry and technology. Therefore, if inflation continues to rise rapidly and keep on accelerating in 2022, which I noted was a headwind for gold, this could actually benefit silver. This asset is more sensitive to broader economic circumstances so, if global growth is pushing inflation up, silver could be a beneficiary.
Let us take an example to illustrate this reality. One effort in particular that is gaining traction, in the U.S. and globally, is generating solar power. This is a trend that is unlikely to subside any time soon, and requires the installing of solar panels. Each solar panel requires input commodities to create, with silver being one of those primary inputs. In fact, each solar panel requires quite an enormous amount of silver, as well as other materials, as shown below:
My thought here is the practical applications of silver offer a way to balance precious metals exposure for individual investors. The positives for this particular metal can hedge the negatives for gold, and this makes CEF a desirable choice for me when evaluating this space.
This has been a boon of a year for investors broadly speaking, but those with gold and silver investments are probably less enthusiastic about 2021. However, I see the recent weakness as an opportunity to build on core positions. These are commodities that often act as hedges against equity losses, inflation risk, and can benefit when the global economy is growing and prospering. CEF is a good way to get exposure in this space. The fund trades at a discount to NAV, is appropriately balanced between gold and silver, and has plenty of liquidity. Looking forward, I believe the fund will trend upwards, but caution investors about getting too aggressive, as inflation remains a key headline risk we have to monitor closely. If inflation keeps accelerating, a bull case could break down. Therefore, I continue to hold CEF and will look to add to it on weakness going forward, but I would encourage readers to be selective on any new positions at this time.
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This article was written by
Macro-focused investor, working for a major U.S. bank. I grew up in New York, but escaped to North Carolina. I was a D1 athlete in college (men's tennis) and compete competitively to this day. My Bachelor's and MBA are both in Finance.
I provide reasoned, fact-based analysis of different funds and sectors. I list my portfolio here so readers can gain insight into what I am buying/holding, what I'm not, and how that lines up with the views I present in my articles.
Broad market: VOO; QQQ; DIA, RSP
Sectors: VPU / BUI; VDE / UCO; KBWB; XRT
Non-US: EWC; EWU; EIRL; EWA
Dividends: DGRO; SDY, SCHD
Municipals/Debt Funds: NEA, BBN, PDO, BGT
Stocks: WMT, JPM, MAA, SWBI, MCD, DG, WM
Cash position: 25%
Disclosure: I/we have a beneficial long position in the shares of CEF, BTC-USD either through stock ownership, options, or other derivatives. 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.