Your Precious Portfolio

Toronto’s three precious metals funds stood up well to the ups and downs of gold prices.

The goldbugs were having a field day late last summer when the price of gold popped up through the $440(US) mark, having risen more than $100 per oz since June. But then, as gold is wont to do, the price collapsed by $60 within the next two months, leaving more than one speculator mourning the loss of hard-earned dollars.

That kind of action is great for traders who move in and out of the market on a daily basis. But for longer- term investors who are willing to wait out a golden ride to the top, these fluctuations can be agonizing. One alternative for the fainthearted is the three gold funds which trade on the Toronto Stock Exchange. Recent history suggests these are vehicles of much less volatility.

Two of the three funds were able to hold the high ground after gold traded down from its September high. For example, bgr Precious Metals closed at $9.50 per share on Sept 22, and by Dec 5, when gold was trading $50(US) lower at $390, bgr was still changing hands at $9.50. Central Fund of Canada slipped only 7% during that same time, even though the gold price had fallen 23%. Even the worst performing fund during that period, Goldcorp, traded off only 17% to $8.75. The evidence suggests that precious metal funds may be the way to go if you want to avoid the little rollercoaster rides that have become synonymous with the bullion markets — especially if you lack either the time or experience to work your trading on a daily basis.

All funds are not equal, in terms of either asset mix or objectives. Central Fund, for example, is strictly a bullion holder. “We consider ourselves custodians rather than managers,” says Ian McAvity, a director of Central Fund. In late December the fund held 81,000 oz of gold and 4.1 million oz silver, representing 95% of its total assets. The fund’s managers aren’t completely passive, however, as they occasionally will sell options against a maximum of 10% of fund holdings to protect against falling prices.

Goldcorp holds about 65% of its assets in bullion with the remainder held in gold mining shares. Bgr, on the other hand, held only 20% of its assets in gold, platinum and palladium during the latter half of 1986. Half its portfolio consists of North American gold equities, with another 25% in Australian and South African gold mines, and the remaining 5% in cash.

Pierre Lassonde, one of bgr’s three managers, says he strives to pick well- run, established gold miners in the “Tier One” category, as well as some emerging gold companies which have been dubbed “Tier Two” (such as Mascot Gold Mines).

One of the curious anomalies of the gold funds and closed-end funds in general is that they trade at a discount to net asset value. In contrast to mutual funds, which are known as open-ended funds because their shares are constantly being issued and redeemed, closed-end funds issue a set number of shares which trade on exchanges. Share values are then established by the investing public.

However, this price is almost invariably lower than the per-share value of the funds in the event assets were sold and the proceeds distributed among shareholders. Bgr, for example, had a net asset value of $11.98 on Dec 4. The shares were trading on the open market at $9.50. Central Fund’s net asset value was $7.59, while its shares were selling at $6.62.

No one has been able to adequately explain the discount. Eric Kirzner, a University of Waterloo professor and an authority on global investing, notes that several arguments have been advanced: the discounts reflect the costs of liquidating a fund’s portfolio; they reflect the fund’s management fee; the funds aren’t aggressively promoted in the way mutual funds are; and the funds aren’t accorded the favorable tax treatments which are given their open-ended counterparts.

Whatever may account for the discount, Kirzner cautions that it represents another variable that must be taken into the investment equation. “It represents an extra form of risk that you don’t have in buying gold bullion,” he explains. The discounts could change over time. Let’s assume that over a period of time gold prices stay in a narrow trading range. An investor buys the shares of a gold fund that’s trading at a 15% discount to net asset value. For some reason (mismanagement perhaps or an increase in management fees) — or for no apparent reason — the fund’s discount widens to 20%. Our thoroughly frustrated investor has watched his or her investment decline in value at a time when gold prices held steady.

Across the range of funds, the discounts to net asset value present another puzzle: in percentage terms, they’re not alike. Bgr has recently traded at a discount of between 20% and 26%, while Central Fund’s discount has been around 11%-12%. McAvity attributes Central Fund’s narrower discount to several factors, namely a stable holding of bullion so that the vagaries of gold equity prices don’t affect the fund’s share values. Another reason given is that the fund has no warrants outstanding that would dilute shareholder equity later on if exercised.

Unfortunately there is no pat answer to the discount conundrum. Investors simply must accept it as one of the investment variables. In fact there’s always the outside chance in a sustained gold bull market that the discounts could turn into premiums. In a major market move, such as the one envisaged by well-known commodity trader Albert Friedberg (who says gold will soar beyond its all time high in the not-too-distant future), the gold bandwagon could well carry the fund’s market values beyond their net asset values.

For those bullish on gold, Kirzner suggests two different approaches — one for the well-to-do and another for those with limited funds. Generally he favors bullion over the funds. With the metal holding, there are no management fees, no discount and no worries over asset mix. For those investing $15,000 to $25,000, for example, he recommends buying bullion across the whole group of precious metals (such as 10 oz each of gold, platinum and palladium, and 100 oz silver). Concerning the smaller investor, who can get whipsawed when the prices fluctuate and who may be forced to liquidate in a hurry, funds are perhaps the safest way to hold bullion. Olav Svela is managing editor of The Moneyletter.