Intelledgement’s model portfolio utilizes (mostly) exchange-traded funds to implement a macro-focused investment strategy. Consequently, we periodically review the funds relevant to any particular aspect of our overall strategy—e.g., all the funds that invest in India or agriculture, or short the dollar—to ensure that the particular fund we choose as our investment vehicle is the best choice (or at least a good one). In order to minimize potential liquidity issues, we generally eschew any fund that has less than one billion dollars under management, or trades fewer than one million shares per day on average. We occasionally make exceptions to this practice; for example when we feel strongly about the need to take a certain position and the fund choices to implement it are limited or when a fund with a large enough market cap has lower volume due to a high per-share price.
We have been satisfied investors in the SPDR Gold Shares ETF (GLD) more-or-less since the inception of the Intelledgement Macro Strategy Investment Portfolio at the beginning of 2007. (We sold our gold and silver funds in February of 2010 thinking the dollar would strengthen on flight-to-safety concerns…and got a sharp reminder that trying to outguess the market tactically is very hard to do as the price of both commodities soared. We got back in three months later, having missed a 10% rise in gold and a 17% rise in silver.) Since that time, GLD has reasonably faithfully tracked the price of gold, which has mostly gone up.
We still think gold is a good place to store some value as we explained in our original recommendation for GLD back in 2006. So we don’t want to pull any funds out of gold, but what we are doing is making a lateral move: selling the GLD ETF and rolling over all of the proceeds of that sale—our original investment plus the profits—into the Sprott Physical Gold Trust closed-end mutual fund (PHYS).
We are making this move for two reasons. First, being a closed-end mutual fund, the tax treatment for PHYS capital gains is more favorable for US investors: 15% on long-term PHYS gains compared to your ordinary income tax rate—probably 28%—for any GLD gains regardless of how long you have held the investment. Of course, this does not matter if you hold the shares in a retirement account, but for those investors working with a regular brokerage account, it is a material advantage. Secondly, so far—since the inception of the fund in February 2010—the PHYS fund has actually outperformed gold bullion by 2% as compared to the slight underperformance of GLD since its inception (November 2004). This may be a transitory effect, but there are some reasons why the market seems to prefer PHYS to GLD—for more on this see our Motley Fool weblog post—and insofar as that helps the former to outperform the latter, we are willing to let the effect work in our favor.
One of the reasons PHYS is preferred is that some investors consider that GLD is more vulnerable to systemic risk than PHYS. We believe that if the system genuinely collapses, no paper gold holdings are likely to avail one; at that point, you will need silver coins, tobacco, alcohol, and aspirin for purchasing any necessities of life that you cannot provide for yourself. The market also likes PHYS because it is the only fund that enables investors to redeem their shares for physical gold. But this is not a genuinely practical option, as you need to have about $400,000 invested in the fund to afford the tradein for a gold bar—they are not about to incur the hassle and expense of dividing up a bar for you. Anyone who seriously could afford to and wished to acquire that much gold could do so more cheaply buying from a dealer. But again, if the market bids the price of PHYS up relatively higher because of irrational beliefs that it is safer and easy to convert shares to bullion, as PHYS owners we will cheerfully accept all contributions to our share valuation.
Of course, with a marketcap of $2 billion and average trading volume of 1.5 million shares, PHYS exceeds our liquidity requirements (minimums of $1 billion marketcap and one million shares average daily volume). Sprott store all their bullion at the Royal Canadian Mint, who are responsible for auditing and issuing bar lists. Since the 2009 brouhaha over the $15 million of “missing” bullion that turned out not to be missing, the mint has tightened up their accounting procedures and now considered one of the safest, if not the safest and most honest storehouses of gold bullion in the world. We also like the fact that—as with GLD—the gold is stored outside the USA, considering what happened in the 30s when the government confiscated everyone’s gold.
Previous gold-related posts: