CEF Announces Secondary Offering – ETF Lesson Part V

Posted by kid dynamite
on March 29th, 2011

First of all: yes, I know that $CEF isn’t an ETF - it’s a closed end fund – which is also confusing because people often use the abbreviation CEF for Closed End Fund. CEF is a CEF.

The Central Fund of Canada ($CEF) is a closed end fund which holds silver and gold. As of recent prices, its holdings are weighted roughly 55% silver and 45% gold.

As of yesterday’s market close, CEF was trading at more than a 9% premium to its Net Asset Value. Now, remember what a premium in a closed end metals fund means: it means that there is demand for the shares of the fund – not that there is a shortage of the metals underlying the fund. In fact, as a result of this demand for their shares, CEF is doing what any normal fund trading at a juicy premium to NAV should do – they are doing a secondary offering. They will increase assets under management, and thus reduce the annual expense ratio.

“Central Fund will only proceed with the offering if it is non-dilutive to the net asset value of the Class A Shares owned by the existing Shareholders of Central Fund.

The remaining amount of approximately U.S.$394,295,000 of the original U.S.$1,000,000,000 provided for in the base shelf prospectus is available for this offering.

Substantially all of the net proceeds of the offering will be used for gold and silver bullion purchases, in keeping with the asset allocation policies established by the Board of Directors of Central Fund.”

I’m already reading “what does this mean?” questions on other blogs, so let’s take this step by step:

1) They won’t do the offering if they can’t sell the new shares for at least Net Asset Value. This is another way of saying that they will not dilute current shareholders. I wouldn’t expect them to have any issues getting the entire size done. They did a $ 375MM secondary in May, 2010. The offering is not dilutive to NAV, but it is dilutive to the current share price (which is well above NAV), as it creates additional share supply. CEF’s premium has proven to be resilient in the past, however, as investors continue to clamor for shares, and the Central Fund continues to issue them shares. Their short form shelf prospectus lists a handful of such secondaries that they’ve done in the past, before that May, 2010 offering. There was also a November, 2009 offering of $230MM:

Central Fund issued 11,900,000 Class A Shares at $10.80 per Class A Share, for gross proceeds of $128,520,000, pursuant to a public offering which closed on September 26, 2008.

Central Fund issued 12,500,000 Class A Shares at $10.40 per Class A Share, for gross proceeds of $130,000,000, pursuant to a public offering which closed on February 3, 2009.

Central Fund issued 20,000,000 Class A Shares at $10.50 per Class A Share, for gross proceeds of $210,000,000, pursuant to a further public offering which closed on April 16, 2009.

Central Fund issued 11,040,000 Class A Shares at $11.90 per Class A Share, for gross proceeds of $131,376,000,
pursuant to a further public offering which closed on August 13, 2009.

2) They will offer up to $ 394MM in shares, which is what they have left on their shelf registration which allows them to do this periodically without a whole new series of complicated SEC filings.

3) They will use the proceeds to buy gold and silver bullion in their existing proportions, which is roughly 50 ounces of silver for each ounce of gold, and which will maintain a ration of roughly 55% silver and 45% gold in the fund. This means that they will be buying approximately 55% x $ 394MM = $ 216MM of silver, or almost 6mm ounces at roughly $37 per ounce. They’ll also buy roughly 125k ounces of gold. Hopefully, this demand will be bullish for gold/silver, although I don’t know if they’ve already constructed some sort of purchase arrangement which may be partially priced in.

Again, folks, this is a NORMAL thing. This is what a closed end fund manager SHOULD do when his fund trades at a huge premium – unless, of course, he’s trying to perpetuate the myth that there’s no metal out there to buy (and yes, Eric Sprott and $PSLV, I’m talking about you). When investors demand your shares, it’s perfectly natural to sell them more shares – CEF’s past secondaries demonstrate what I’d call “normal” market issuance to satiate demand.

Remember this CEF offering the next time someone tries to tell you that there’s no silver available to purchase. CEF is yet another market checkpoint that would beg to differ – they clearly think that they can find silver.

Somewhere in here I feel the need to reference The Man, Steve Wynn, who once said:

“These unnatural movements in value, no company gets to be worth twice as much in 60 days as it was before to any intelligent person, so when that happens, we take advantage of it. If everybody is so hungry for shares, we let them have some. If the shares go down, we buy them. And that, that is a statement of policy in this company, period.”

{Although WYNN’s offerings are a bit different, in that they are dilutive to existing shareholders. The point to focus on is satiating demand for shares. If they’re hungry for them, we let them have some!}

I remain long SLV.

-KD

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