CEF - CEF: A Few Reasons I Still Like Gold And Silver

2023-10-31 15:26:34 ET

Summary

• The article discusses the Sprott Physical Gold and Silver Trust as an investment option at its current market price.
• I have recommended and owned this product for many years and believes it offers a convenient way to invest in both gold and silver.
• Despite interest rates, gold has been performing well, making the Sprott Physical Gold and Silver Trust an attractive investment.

Main Thesis & Background

The purpose of this article is to discuss the Sprott Physical Gold and Silver Trust (CEF) as an investment option at its current market price. This is a trust that "invests in unencumbered and fully-allocated physical gold and silver bullion in London Good Delivery bar "form", managed by Sprott.

I have recommended and owned this product (along with the iShares Gold Trust ETF (IAU)) for many years. But it has been a while since I covered CEF in an article, so I thought it was time to get my update on it. Looking back, the last time I reviewed it was in 2022, when I placed a bullish rating on it. In hindsight, this was a reasonable call:

With Q4 starting off on a rough note, I thought it was timely to consider if CEF deserved a reiteration of this buy call. After review, I do believe so, as gold (and silver) are both safe haven hedges that investors will likely continue to be drawn to for a variety of reasons. I will take each of the reasons in turn below.

Gold Has Been Pushing Higher Despite Interest Rates

The first topic I will consider is the impact from geo-political risks. This is central to why I see gold (and CEF by extension) as buys at these levels. The reality is this outlook may seem counter-intuitive given the push higher in interest rates in the US - and elsewhere. Gold and other metals tend to have an inverse relationship with rates because when investors can earn higher yields elsewhere, it makes the non-yielding metals space look less attractive by comparison. Through 2023, this has mostly been the theme, so this is a risk that readers should consider:

So - with this being the case - why would I recommend CEF?

The answer lies with more recent developments, notably the military conflict in Israel and Gaza. This unfortunate catastrophe, coupled with the ongoing uncertainty it presents, raises the attractiveness of safe haven metals such as gold and silver. It should not be a surprise then, since the attacks in early October, that gold in particular has roared upward (despite a macro-environment with higher interest rates and yields):

Here-in lies where I become a bull going forward. I do not believe the conflict in the Middle East is going to resolve itself soon in a peaceful fashion. The chances of broader escalation - whether into new territories or by bringing in other countries (like the US) - has a higher probability than the conflict ending swiftly or peaceably. For this primary reason, I see a continued backdrop that is positive for both gold and silver due to the "safe haven" status. This plays directly into the hands of CEF.

Bonds Have Not Been A Useful Equity Hedge

My next topic considers alternative options when looking to protect one's portfolio against volatility and/or equity declines. Gold (as well as silver and other metals) are certainly viable candidates for this objective. But they are by no means the only ones. Probably the most common among retail investors is bonds. And herein lies the problem for 2023. Bonds have been a very poor hedge of late, questioning their usefulness in a rising rate environment.

In fact, when looking at investment-grade quality bonds (the most common way to hedge equity exposure), we see the second half of the year has had miserable performance thus far. While corporate bonds rallied in the early stages of the year on the hopes of a less aggressive Federal Reserve, that outlook was misguided and the later results were fairly painful:

As you can see, bond investors have seen some sharp losses in the past two quarters, and over the past two years. That has called their usefulness in to question in the short-term.

Readers may be asking - how is this relevant to gold, silver, or CEF? And that is a fair question because this fund does not own bonds. But my point is that bond's poor performance increases the relative attractiveness of other equity hedges. This would include gold in particular, hence why I see this as another supporting reason to own CEF. When investors are looking for portfolio protection, they have a number of options. But if one option - in this case bonds - is performing poorly, they are going to look elsewhere. This supports the view that demand for gold and silver are going to increase going forward, as long as bonds continue to struggle.

Why Do We Need Equity Hedges?

Expanding on the prior discussion, it is worth considering whether readers should be building on to their equity hedges at the moment. After all, the market has been dropping, so it could be a better idea to start buying equities, rather than the assets that perform well when equities do not. In fairness, this is always a risk to owning gold, silver, and/or CEF - if the equity market is set to perform strongly, investors are going to miss out.

But the outlook ahead for equities is quite mixed. This doesn't mean avoid them, but it does suggest to me that now is a reasonable time to build on to metals or other hedges. When the outlook is uncertain, that is when I want gold in particular. And the outlook for corporate earnings (a major driver for P/E ratios and ultimately share price levels) has gotten cloudy indeed:

Of course, estimates are just that - estimates. Corporations and consumers in the US have been fairly resilient to this point and expectations could be surpassed in the next few quarters. We won't know until it happens. But the pessimistic tone on many corporate earnings calls of late, coupled with declines in future earnings estimates, leads me to believe now is a reasonable time for some caution. This supports the buy rating on CEF, and other US equity hedges that are open to retail investors.

Despite A Gain, Valuation Now More Attractive

Digging in to CEF specifically, another positive attribute is the trust's valuation. Last year I highlighted this point as well, when CEF stood with a discount to NAV of 2.7%. Today, despite CEF rising by almost 5% in market price since that time, the discount has actually widened:

The thought here is straightforward. CEF has an attractive discount to NAV and it is actually more attractive since my last review, despite an overall positive return in the interim. This is a win-win scenario in my book, justifying my "buy" outlook for the trust.

Silver Still In Demand Too

Another point to focus on when evaluating CEF is the outlook for silver. As mentioned, this product owns both gold and silver, so one would want to be fairly bullish on the pair before buying in:

There are a couple reasons why I view this positively. One, this one product allows me to own exposure to both assets, which presents an easy way to diversify. Two, while gold and silver both have relative safe haven status - gold is really the paramount metal in that regard. But that doesn't mean silver isn't as "good" as an investment.

In fact, silver is perhaps more of a forward-thinking investment. The metal is used in many industries including electronics and solar panels - two areas where demand has been expanding globally as countries try to shift their economies away from fossil fuels. Case in point, the demand from photovoltaic cells (the technology for light conversion to electricity within solar panels) for silver has grown at a rate of 12% a year for the past decade:

What this shows is steady demand for the metal and a trend that is showing no sign of abating. I like this arena as both a short-term and long-term play as a result and see CEF's inclusion of silver in its portfolio as a benefit, not a detriment. While the trust is still predominately gold, a roughly one-third weighting to silver should give the share price a boost over time.

Bottom-Line

CEF has seen a big boost over the past year, although its performance in 2023 has been moderate. With that backdrop, I believe the current price offers a reasonable opportunity to see further gains. The trust trades at a discount to NAV and is poised to benefit if investors remain worried about continued instability in the Middle East and/or economic uncertainty. Ultimately, I believe CEF is a strong choice for those seeking an equity and volatility hedge. As a result, I am keeping the "buy" rating for CEF in place, and suggest to my followers that they give this idea some thought at this time.

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