About That CEF Premium (Discount)

$CEF (Central Fund of Canada) holders are wondering what has happened to the premium of their beloved fund.   While in the past CEF typically traded at a 4-10% premium to Net Asset Value, their recent secondary offering, combined with the turmoil in the silver markets, has resulted in the shares now trading at a discount to NAV of more than 5%.

Let’s look at some possible explanations.  First off, CEF’s assets are 55.6% silver, 43.1% gold.  So why the collapse in CEF’s premium?

1) the most obvious reason – without a creation/redemption mechanism, CEF trades based on supply and demand for shares in the market.  Their recent secondary offering brought more supply, and thus, requires more demand in order to maintain the same premium.

2) silver silver silver – as investors clamor for pure silver exposure, they might be selling CEF, which isn’t 100% silver, to buy other silver pure plays.  This explanation explains the poor performance on big silver up days, but not big silver down days, like today, where CEF’s discount to NAV widened.

3) anti-silver: as investors reduce silver exposure any way possible, they might be selling their CEF positions.  This seems to be the case today.

4) The most important reason, and yet a question no one is asking:  why should CEF trade at a premium?  Just because it traded at a premium in the past (due to a shortage of shares- an imbalance of supply and demand for SHARES), doesn’t mean that it will or should trade at a premium in the future!

But a 5% discount – that seems steep, right?  Well, there’s no pure arb to “fix” this “mispricing” of CEF.  The redemption clause in their prospectus isn’t robust at all:

“Redemption. Any holder of Class A Shares is entitled, upon 90 days’ notice, to require Central Fund to redeem on the last day of any of Central Fund’s fiscal quarters, all or any of the Class A Shares which that person then owns. The retraction price per Class A Share shall be 80% of the net asset value per Class A Share as of the date on which such Class A Shares are redeemed. The articles of Central Fund provide for the suspension of redemptions during specified unusual circumstances, such as suspensions of normal trading on certain stock exchanges or the London bullion market, or to comply with applicable laws and regulations.”

So traders can’t buy CEF and redeem it for the metallic value.

Now, having said all that, and having laid out the reasons why CEF need not trade at a 5% premium to NAV, I put on a trade today anticipating that the discount will not persist.  I bought CEF, and shorted SLV and GLD in the proper proportions to CEF’s assets.   If the metals complex sells off further, CEF’s discount to NAV may widen, but I’m hoping that at some point in the not-so-distant future, this discount will narrow again.

-KD

long CEF vs short GLD and SLV.  unrelated, I also have a long position in SLV, and SLV puts

note: the “creation/redemption mechanism” is what people in The Business call the ability to create and redeem ETF shares daily in exchange for metal.  On another blog several weeks ago, a novice reader accused me of “lying” when I wrote that PSLV doesn’t have a creation/redemption mechanism to keep the price in line.  $PSLV, despite having a clause in their prospectus to allow for redemptions of shares for bullion, does not have a creation/redemption mechanism as the term is normally used in The Business, and neither does $CEF – although CEF also has a clause that allows for redemption of shares at a discount to NAV (80%)

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