No Silver Lining, Part 2

Eric Sprott runs a range of hedge funds, precious metal funds and other funds in Canada.  I am invested in his gold fund (PHY-U).

I have written before about Sprott’s Silver Funds (PHS-U and PSLV).  Something strange happened on Thursday, the funds fell 4% for no apparent reason.  Here is a chart of PSLV against the SLV (SLV is a huge silver ETF).

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The objective of PSLV is to track the price of silver, which it is clearly not doing.  A quick scan found several blog entries trying to explain why PSLV was behaving like this.  The bottom line is that I don’t really understand what is going on with this fund, and you should never invest in something that you don’t fully understand.

So, could the same thing happen to the gold fund (PHY-U) which I own.  Well, I don’t know but I’m worried that perhaps I don’t understand this investment either.  There is another problem: PHY-U is illiquid.  The bid-ask spread is often quite large and the volumes are sporadic.  Given the risk of sudden drops in the price and of illiquidity I think it’s time to get out, and get into a simpler vehicle such as the GLD (a huge gold ETF).  I will consider…

Exiting Telus, Entering Gold

After a routine scan of my holdings is see that Telus (T.TO) has fallen below my mandatory screening criteria of: 10% return on investment with a margin of safety of 10%; and providing a dividend. My analysis of Telus shows that the return I can expect on the stock is only around 9.5% at the current price (see chart below). I have owned the stock for almost 2 years and have seen the price run up by over 53%. I have also received an annual dividend yield of around 4%. It’s been a great investment but it’s time to take the money and run.

  • SELL Telus (T.TO) @ $54.21

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This gives me an opportunity to add gold to the portfolio. More specificaly, I’m looking at the Sprott Physical Gold Trust (PHY-U.TO), which owns physical gold bullion held in the Canadian mint. This will give me a gold holding of around 6% of the overall portfolio.

  • BUY Sprott Physical Gold Trust (PHY-U.TO) @ US$13.46

My investment policy does not address gold, only stocks and bonds. So what does Benjamin Graham say about gold?

“The near-complete failure of gold to protect against a loss in the purchasing power of the dollar must cast grave doubt on the ability of the ordinary investor to protect himself against inflation by putting his money in ‘things'” – Benjamin Graham

In his commentary, Jason Zweig notes that this is one area where Benjamin Graham is commonly thought to be mistaken, and that gold has handily out-paced inflation in the years after Graham wrote his assessment.

I will limit my gold holdings to 10% of the overall portfolio.

POSTMORTEM

One month after this trade, on 7th August 2011, this looks like a very good call. Telus is down 8% and the Sprott Physical Gold Trust is up 8%. This chart (below) represents pretty much the ideal result of a smart trade.

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The Silver Lining

A couple of weeks ago I wrote about Eric Sprott selling his own silver fund. I did more reading and it seems he sold physical silver and bought silver miners because he noticed a discrepancy between recent advances in physical silver (high) and those in the miners (low). Let’s take a look.

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Sure enough, physical silver (the green line in the 6 month chart above) advanced far beyond silver miners (the blue line), especially in the last couple of weeks of April, which is when Sprott made his trade. Nice work Mr. Sprott!

Hmmm. I wonder what gold looks like.

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Physical gold (the green line in the 6 month chart above) has lagged the much more volatile gold explorers (the blue line), but caught up at the beginning of May. The discrepancy was greatest in early to mid-February. An investment in physical gold then would have resulted in a return of 15% by the beginning of May when the discrepancy closed.

This could offer a useful (but speculative) trade in the future: pairs trading, or shorting the higher of the pair and going long on the lower of the pair. I’m not sure what timeline to use when assessing which is high and which is low: is six months always an effective period to judge? Today, gold explorers are down and physical gold is up (see 6 month chart above) so the trade would be:

  • Long gold explorers (the GLDX)
  • Short physical gold – using Horizons BetaPro COMEX Gold Bullion Bear Plus ETF (HBD.TO)

Let’s look at this again in a month to see how this trade has performed.

POSTMORTEM

I predicted that a pairs trade of long Gold Explorers (GLDX) and Short Gold (HBD.TO) would be profitable within one month. It’s June 21st 2011 and the results are in: a 6% loss!

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Why have gold explorers not advanced? Interestingly, the GLDX has moved up over 2% today (June 22nd). Perhaps my prediction will come true later.

No Silver Lining

Silver has been hot lately. The theory seems to be that gold and silver should move up and down somewhat in tandem, and gold has seen such huge gains lately that its gravity should pull up silver too. Local fund manager Eric Sprott has predicted great things for silver and has created a fund representing actual silver bullion (PHS-U.TO).

Well, silver took a huge dip this week. Sprott’s silver fund is down from last week’s close of 21.65 to this week’s close of 15.76 (down 27%!). Interestingly Sprott’s hedge funds sold their holdings in his silver fund in late April. Indeed, Sprott sold his own holdings. That makes him a smart investor, but perhaps not too popular with his silver investors!