Going Beyond the Statistics: A Look at the $PHYS Premium

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  • on September 23rd, 2010

The other day on Chart.ly I tweeted a chart of $GLD vs. $PHYS showing how $PHYS is trading at a historically low premium to $GLD.

Also recently @Xiphos_Trading noticed the same thing.

If you’re not familiar with $PHYS it’s Sprott Physical Gold Trust, a Canadian closed end fund that invests in gold buillion (and unlike $GLD allows you to take delivery).  While I am not a gold bug, I do like to look at correlated assets for long-short opportunities.  Here’s the deal on $PHYS:

It’s trading at a 3.31% premium to NAV.  While $PHYS has only been trading since February, this is historically low:

My guess was that $GLD is probably a good proxy for NAV of $PHYS since it is liquid and runs with gold.  I ran the same analysis above on $PHYS vs. $GLD since inception:

As you can see while the magnitude of premiums are a bit different, the distribution is very similar.

While there is no fundamental reason for this fund to trade above NAV, it is very likely to do so.  I believe that there will be a perceived physical premium and its unlikely that there will be any “tests” of this structure in the near future.  Thus, the downside of such a trade is limited, in my opinion.

From a purely statistical perspective the Long $PHYS Short $GLD trade makes sense, but the past may not be the best indicator of the future.

On September 17th, Sprott did a follow on offering that priced I believe 10% above NAV.  They are using the proceeds of this offering to buy more bullion.  There’s a discussion of this over at Zero Hedge. Since the offering, the premium has been sucked out.  While it doesn’t appear that offering itself was dilutive, it increases the supply of this “physical” gold exposure and thus makes sense that it’s premium to NAV would get shrink.  The follow on was roughly 50% of the initial offering so for that 50% increase in supply we’re going to have to see a 50% increase in demand in the future just to get to the supply/demand mechanics that produced the historical data above.  A similar fund, $CEF, Central Fund is currently trading at 8% to NAV, so from a relative value standpoint, new demand for this type of exposure may get sucked into $PHYS, which could help a bit.

Also the historical data includes the “mini” Euro Crisis we had back in the spring and early summer.  Most of the high premiums were during that time period, when there was real fear about the future of the Euro.  Gold was looked to as a play in general currency instability back then and $PHYS commanded a premium during that time of fear. In short, the historical data is limited and could potentially contain a major outlier.

While I believe the downside is limited in such a trade, I’m not sure how much upside there is after you take out the cost of putting on and carrying such a position.  With $CEF trading at 8% premium that’s the ceiling I would give for upside (5%) in the current environment.  Should we have renewed currency fears or continuing erosion of this spread, however, the trade may get more interesting and I’ll reevaluate.

Regardless, hopefully this analysis was a testament to not relying solely on charts, or historical or statistical data when looking at pair trades – because sometimes it’s just so tempting.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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