Let’s Talk About PHYS’s Shrinking Premium to NAV

I’ve been very vocal as of late warning investors to be cautious of buying $PSLV – the Sprott Physical Silver Trust – at a huge premium to its net asset value.  For some reason, people insist on rationalizing the premium, (ie: “it’s because PSLV actually owns real physical silver”) which is strange, considering that early last year we went through this EXACT same exercise with $PHYS – the Sprott Physical Gold Trust.

PHYS initially traded at a huge premium to NAV, not because the market was endorsing it as a better “physical” product (as some alleged, incorrectly, as we’d soon see definitively), but simply because there weren’t enough shares outstanding relative to demand, and there was no way for the market to “arb” the premium.  There was a small pool of investors readily willing to pay a huge premium, but not a limitless pool of such investors.  Sprott did a number of PHYS secondary offerings (selling more shares in the trust and using the proceeds to buy gold for the trust),  supply satisfied demand,  and the premium has come way down.  $CEF (Central Fund of Canada) has done the same thing – a number of successive secondary offerings have resulted in its premium to NAV trading much lower than it had been previously.  The premiums on each of these instruments (PHYS, CEF)  may rise again (more on that later, as well as a trade I have on that is certain to surprise a number of readers), but keep in mind that with more shares outstanding, a larger pool of investors willing to pay the premium is required to attain the same premium.

The PHYS website has a series of bar charts showing the distribution of daily NAV premiums over different calendar quarters.  Unfortunately, they don’t have a chart for Q2 2010 – the Trust’s first full quarter of trading (it began trading in late February, 2010).

In Q3 2010, the distribution is centered around an 8-10% premium to NAV with significant variance.

Q3 2010 PHYS Premium to NAV

In Q4 2010, the distribution is centered around 3-4% premium to NAV, and is a much tighter distribution.

Q4 2010 PHYS Premium to NAV

In Q1 2011, the distribution has more variance again, with premiums in the 4%-6% range most common.

Q1 2011 PHYS Premium to NAV

In Q2 2011, the distribution is similar to Q1 2011, only with smaller average premiums – in the 1%-4% range.

Q2 2011 PHYS Premium to NAV

Now,  Sprott just completed another secondary offering of PHYS shares.  For anyone with even the most basic understanding of what causes the premium to fluctuate (more demand for shares relative to supply of shares!), it should be no surprise that additional supply of shares resulted in a lower premium.  The current premium is on the lower end of its historical range, trading at under 3% over NAV.

This is not because, as one popular precious metals commentator put it (and I wish I could make this stuff up): “the bankers are shorting Sprott’s gold because he bought 6.6 tonnes of physical gold the bankers need this gold for the comex and instead Sprott takes it off the market. they are thus “put into the doghouse” by the bankers as their positive to NAV falls.”  Seriously folks – if your precious metals guru doesn’t understand ETFs and Closed End Funds (and it’s positively clear that most do not), you need to make sure you don’t listen to the nonsense they are feeding you about these products.

The premium falls because, as more shares are issued, you need an increasingly large pool of investors willing to pay a premium.  The more shares you issue, the more investors willing to pay the premium you have to find.

So, having said all of that, I recently bought PHYS and shorted $GLD against it.  This is a trade on the premium to NAV for PHYS, expecting the premium to increase.   Although I just noted that it’s harder and harder for the premium to reach prior levels after each new secondary offering, I think that there is relatively low risk in this trade.  While there is no reason in my mind for PHYS to trade back to a 10% premium, a premium in the 6% range might be possible given another wave of gold optimism and a new wave of retail investors in the sector.  Additionally, unlike the short PSLV vs long SLV trade I have on, which is making the exact opposite bet about PSLV’s premium to NAV, the PHYS trade has low carrying costs – I don’t have to pay a hefty fee to borrow GLD, and I don’t have to worry much about the borrow being pulled from me, as I do with PSLV.


disclosures: see the body of the post.  Not a single word of this post would be any more or less accurate if I didn’t have these trades on.  I do not give investment advice on this blog – although I described the trade I have on as “low risk,” it’s also correspondingly low reward.


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