Central Fund Of Canada – An Alternative Investment Vehicle For Precious Metals

Gold has been considered for centuries the “ultimate store of value.” In a world where governments in developed countries as well as their central bankers have become increasingly adept at guiding their economies through sometimes even the most turbulent of economic and financial squalls, gold’s role as the “ultimate hedge” against financial calamity has become increasingly something of a historic curiosity rather than something that affects the decisions of many of today’s investors. Exceptions are those die-hard gold bugs including some who still hanker for a return to some kind of international gold standard under which all currencies are pegged to or backed by gold.

In the last few years, however, it is true that gold has had something of a resurgence. This was partly because of increasing demand for gold jewelry in developing countries such as India and latterly China, but partly also because of geopolitical instability that has generated uncertainties of a more complex and fluid nature than those that ruled during the cold war years with their geopolitical stalemate between the two superpowers based on the terrifying, yet ironically stabilizing, fear of mutually assured destruction. There is also some evidence that the recent formation and purchases of physical gold by gold-linked exchange traded funds (ETFs – see below), have also helped spur demand for gold.

Direct investments in gold may be made through purchase of bullion, coins, jewelry, and other physical forms of the precious metal, but for all but smaller amounts this brings with it the inconvenience and risks of storage and security. For the investor or trader, stocks of gold mining companies provide an excellent way to take a speculative or hedged position on future movements in the gold price. Stocks such Newmont Mining (NEM), Barrick Gold (ABX), Agnico-Eagle Mines (AEM), or Goldcorp (GG) are quoted on the New York Stock Exchange. (The last three of these are Canadian-based companies, however).

While gold mining stocks represent shares in corporations and therefore their individual price movements reflect news that is specific to the individual company, as a group their share prices generally follow the gold price closely. Gold mining companies’ production costs are fixed, so any increase in the gold price flows through to the bottom line, and profits are equally affected adversely by any fall in the gold price. A rising gold price is a harbinger of inflationary pressures and so both gold and gold mining company stocks tend to rise when stocks overall are under pressure and fall when the stock market is generally up on the day.

A purer form of gold (and indeed precious metals) investment/trading play and one that is not well known to many U.S.-based investors is Central Fund of Canada, quoted on the Toronto Stock Exchange and with the symbol CEF on the American Stock Exchange. Calgary, Alberta based Central Fund of Canada is itself not engaged in any kind of mining operations. It is a closed-end investment management company set up in 1961 to hold gold and silver bullion passively on a secure basis. At least 90% of CEF’s assets are maintained in gold and silver. An investment in Central Fund of Canada provides share ownership in this gold and silver bullion, the value of which, together with some cash holdings and other assets, was at August 31, 2007 just under $950 Million (U.S. Dollars). As at that date the split in precious metals holdings was 52% of net assets in gold and 46% of net assets in silver.

It should be noted that silver has somewhat greater volatility than gold, largely owing to the fact that it has fewer commercial and industrial applications, as well as not having the same status as an “ultimate store of value.” For a trading position therefore, the silver element serves to “juice” the position. For an investor, on the other hand, Central Fund of Canada can still be targeted as a way to take a speculative position in gold specifically as well as in precious metals more generally. This is because over time the correlation between the gold and the silver price has a tendency to keep to a settled pattern. Recently this has been around 60:1, with one ounce of gold typically valued around the same as approximately sixty ounces of silver.

Recent developments with the introduction of gold exchange trade funds (ETFs) provide another convenient medium for investors and traders to speculate on or hedge against the gold price. These offer many of the same basic advantages that Central Fund of Canada offers in terms of convenience and easy availability. The significant difference between the Central Fund model and ETFs is that as open-ended vehicles ETFs will tend to trade close to their underlying net asset value.

Central Fund of Canada in common with other close-end vehicles will trade at a discount or premium to its net asset value that at times can be quite significant. (It currently trades at a premium). What the authors particularly like about CEF is its track record – 46 years in existence. We believe that narrow sector ETFs still have too short a track record for all of their advantages and disadvantages as trading and investing vehicles to have fully emerged and we do not as yet have the same comfort level with ETFs that CEF provides us. At the very least, as a kind of older and more mature cousin of the hot gold sector ETFs of today, we would suggest that investors/traders in the latter may have an interest in looking more closely at the not so very well known Central Fund of Canada.

Full disclosure: The authors trade in and out of stocks on a very short-term basis using their own “Contrarian Ripple Trading” technique. Of the stocks mentioned here, they have recently traded CEF, ABX and NEM.

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