Central Fund of Canada (CEF) is a closed-end mutual fund, which means that it trades like a stock on the NYSE. The fund owns gold and silver exclusively -- the metals, not stocks. Closed-end funds trade based upon the bid and ask, without regard to their net asset value (NAV). Because of this they can trade at a price that is at a premium or discount to their NAV. By tracking the premium or discount we can get an idea of bullish or bearish sentiment regarding precious metals. The chart below shows the wild swings of this indicator over the years, with the most extreme reading being a premium of about 30% in 2003, when the interest in gold became a mass market event.

The reason that people have been willing to pay large premiums to own CEF over the years is that it was one of the few ways to own gold without actually having to buy and store the metal. All this changed in 2004 and 2005 when gold ETFs (Exchange Traded Funds) began trading. There are now two of these ETFs of which I am aware -- GLD and IAU. The chart below shows approximately when these ETFs began trading.

You can clearly see how this new competition has made the market pricing much more efficient, causing the premium/discount range to narrow significantly. Also, in the last six months there have been frequent swings between premiums and discounts.

In my opinion the activity of the last six months will be typical of what we'll see in the future, and that the premium/discount range prior to 2005, while interesting from an historical standpoint, is no longer useful as a benchmark for measuring extremes in sentiment. It is unlikely that we'll see anything remotely approaching those levels in the future. This doesn't destroy the usefulness of this indicator as a sentiment gage; however, it appears that it should now be applied as a short-term indicator.

With the more efficient pricing, CEF is now a more viable choice as a vehicle for investing in precious metals. Another advantage is that CEF appears to have tax advantages that the ETFs do not have. Whereas the ETFs do not receive favorable capital gains treatment, CEF may qualify as a Passive Foreign Investment Company (PFIC) for U.S. Federal income tax purposes, qualifying it for long-term capital gains treatment when appropriate. (See the PFIC Statement link at this URL: http://www.centralfund.com/Financials.htm)

This is not intended as a recommendation to buy this security, and I am not qualified to give tax advice. Refer this issue to your tax professional.

© 2005 Carl Swenlin
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