CEF: How To Invest In Gold And Silver As They Rise In 2023
The Sprott Physical Gold and Silver Trust (NYSEARCA:CEF) is a closed-end fund (“CEF”) investing in gold and silver. The metals are fully allocated to and held by the Royal Canadian Mint. Currently the mix is about 2/3 inch gold and 1/3 in silver. Based on their history, I wouldn’t expect this to change significantly any time soon. For gold bulls or who also think silver is cheap relative to gold on a long term historical basis, this CEF could be ideal. Making a straight bet on silver can be a volatile ride.
The structure allows an investor to redeem shares for physical assets, but with very high minimums and fees. However, it is worth mentioning as this feature helps ensure CEF does not trade at a material discount to NAV like other closed-end funds. This becomes clear when considering the very long history of other Sprott closed-end funds such as The Sprott Physical Gold Trust (NYSEARCA:PHYS) and The Sprott Physical Silver Trust (NYSEARCA:PSLV).
CEF’s MER is only 0.49%, so it’s still very competitive compared to various gold and silver ETFs. CEF is large and liquid with AUMs of approximately $3.8 billion.
Is Silver Cheap Compared to Gold?
Silver appears primed to reverse its historic relationship with gold prices, meaning silver is cheap in comparison.
It is not too difficult to envision the gold to silver ratio moving towards the 65 area on the chart below. This would mean silver prices around 30% above current levels in a scenario where gold prices are flat.
At the beginning of the pandemic, it was noticeable that silver was positively correlated with the rise in gold prices and tended to move more. We’ve seen far less of that dynamic over the past five months in gold’s recent surge. As a result, silver appears to have more upside potential for the remainder of this year.
CEF will capture a significant portion of such a trend with its current silver exposure of around 32%. The obvious question, of course, is why not invest directly in silver, such as through the Sprott Physical Silver Trust? While this may appeal to many investors, I happen to prefer the likely less volatile ride on CEF, although I’m still bullish on silver prices. CEF has a slightly lower MER and the 5-year average discount to NAV is slightly larger compared to the Sprott Physical Silver Trust.
Reasons to own silver in 2023
For those who want to delve deeper into silver’s bullish arguments, this article by Sprott himself explains 10 reasons to own silver. To state a reason directly “Silver plays an integral role in technology, particularly in innovations that are critical to promoting a greener future“. I find that quite interesting with all the attention this area is getting. At the same time, silver prices have not been as strong versus gold over the past few months as we have seen at times in 2020.
Gold supply has been limited over the past decade
The world’s top gold miners just aren’t spending nearly as much on investments as we see the price of gold returning to the same highs it saw in 2012.
Decade-long trends like the above act as a powerful potential catalyst for a major gold bull in the 2020s. In the 1990s, investors fell in love with technology and investments in commodities were shunned and the sector underserved. This momentum helped launch many strong uplegs in various commodities, including gold, over the next decade.
Since 2022 was an awfully rough time for tech investors, some similarities are now apparent. Gold was also relatively unpopular for the last decade until it revived a bit this year.
Another limiting effect on gold supply in recent years has been the popularity of gold companies using share buybacks rather than pursuing organic growth plans. To quote directly from this S&P Global article from last year “With gold production plateauing in the near term and expected to decline over the next five to six years, the industry is not making enough new, high-quality discoveries to support the long-term pipeline.” said Kevin Murphy, an analyst at Commodity Insights.
China’s reopening and central bank purchases are positive for gold demand
With gold jewelry demand accounting for about 50% of total gold demand, it is worth continuing to pay attention to this source of demand. China and India are the main buyers in this regard, and February saw China’s strongest wholesale demand for gold since 2014. Specifically, this article also highlights the strong buying interest from the People’s Bank of China since late last year.
Not only the Chinese central bank is showing more appetite for gold. Overall, we saw an increase in net central bank purchases of gold in 2022, with reports that demand got off to a strong start in 2023.
Persistent negative US real interest rates are bullish for gold
There are several inflationary pressures that are to some extent structural and, as in past decades, difficult to contain successfully.
- Previously, I talked about the underinvestment in gold, which is also evident in other commodities, including soft commodities.
- In a world of increasing geopolitical tensions, onshoring is becoming more of a trend story than offshoring these days.
- Surprisingly, despite the heightened risk of recession worldwide, unemployment has not risen significantly, meaning that labor markets are relatively tight.
The first two points above relate to factors that could continue to keep inflation high despite the Federal Reserve’s interest rate hike efforts.
While the last point on wage inflationary pressures is more likely to be resolved by rate hikes, this could be a very negative scenario for other assets such as equities. Gold can still be a better alternative.
With some sluggish structural inflation due to factors like the above, there is a risk that we remain in a negative real interest rate environment.
While the Fed surprised many with its hawkish stance last year, it will be terribly harder to maintain such a stance in the second half of this year. With the delayed impact of monetary policy, we are likely to see broader economic weakness and outside pressure to change course. It is becoming easier to point this out and cut rates as forward indicators suggest inflation may be falling. Currently, this isn’t quite as palatable as they don’t want to be seen as too reactive to a banking crisis.
Inflationary pressures may ease later this year, but perhaps not enough to erase the negative real interest rate environment we are in, which is helpful for gold.
US Dollar risks rise to add another catalyst to the gold bull market
Risks remain on the downside aside from potential Fed rate cuts negatively impacting the USD.
The nation’s mounting debt is once again becoming more of a topic of discussion. Debt servicing costs have risen and Social Security payments coupled with the high CPI are not helping.
Other major players in the global economy, such as China and Russia, are looking for ways to reduce their dependence on the US dollar. I touched on the central bank’s purchase of gold earlier, which is a related point. Added to this is the increasing desire of much of the world to seek alternative trade routes.
The USD held up better than many expected for much of 2022, limiting the extent to which a new gold bull market could form. Increasingly, the signs as above are negative for the USD and bullish for gold.
Also, a limiting factor in gold’s performance as the pandemic took hold was Bitcoin’s popularity. The factors that would normally drive some investors to buy gold have in some cases drawn them to bitcoin instead. While Bitcoin rallied strongly in 2023, I would note its disappointing performance as inflation risks became a major concern in early 2022.
I see the main future performance risks for CEF in the possibility that we will see much of the structural supply-side inflationary pressures I mentioned earlier come to an end. That could happen at the same time as we see a US recession. However, in such a scenario, CEF could suffer less than equities as an asset class. Longer-dated US Treasuries would likely fare better in such an environment.
If inflationary pressures on the supply side abate in a soft landing type scenario, CEF could well underperform equity markets.
Currently, there are numerous tailwinds for gold and silver to continue to outperform this year. Some factors that have held back the rally in precious metals since the pandemic are coming to an end in my view. I’m referring to the USD, which initially held up well, and the Federal Reserve, which has been tightening aggressively since last year.
CEF is a good way to play the continuation of what is likely to be a structural bull market for gold and silver. It often trades at a discount to NAV of 3-4%, which hasn’t changed much in the last five years. With the competitive MER of less than 50bps, it is attractive to those who like the structure of fully accounted for physically backed precious metals held at the Royal Canadian Mint. These characteristics may cause the usual discount to close in the future.