How to Buy Gold at a 13% Discount

A Hedge Fund Secret

Most of us are familiar with the standard, open-end mutual funds where the mutual fund sponsor or investment manager buys shares from investors or sells shares to investors each day at the closing net asset value (NAV).  The NAV is simply the total value of the fund’s net assets (total investments less any debt) divided by the outstanding shares.  

Net Asset Value (NAV) – Funds per share market value

• If a fund owns $50 million worth of stock, the fund has a NAV of $50 million
• If there are 1,000,000 shares outstanding, the NAV/per share = $50

In a standard, open-end mutual fund there is not a fixed number of shares; the sponsor will continue to issue shares no matter how many investors wish to buy and will always buy back all the shares that investors seek to sell.

This is the key difference between an Open End mutual fund, and a closed-end mutual fund.  

Closed-End funds act differently.

The total number of shares available is determined at the launch of the fund (the IPO) and is fixed for the life of the fund – no new shares can be issued, or any shares retired.  

Shares are bought and sold on national exchanges throughout the day – investors trade with one another, not the mutual fund sponsor. These CEFs trade just like any other stock and this is where the opportunity presents itself for everyday traders.

Like any stock, CFs trade at prices determined by the supply and demand of market participants and not by the NAV.  This allows CFs to trade at a premium, where the price is higher than the NAV, or they can trade at a discount, where the price is less than the NAV.  

The Closed-End Fund below has traded at discounts as low as 5%.

If the NAV is $10 and the CF is trading for $9.00, the CF is trading at a 10% discount. A CF may trade at a discount or premium for a variety of reasons:  the impact of mutual fund fees, the fund’s investment focus or the investment manager may be in favor, the fund may or may not be shareholder friendly or due to basic supply and demand factors that present opportunities for prudent traders.

Here’s another Closed End Fund that has traded down to a 14% discount to its Net Asset Value.

CFs allow traders to potentially enter asset classes at a significant discount.

How Do Closed End Funds Have Edge

This discount or premium is an edge for the retail trader, a type of arbitrage or trade driven by the Relative Value concept.  

For example, if the discount to NAV is relatively high (based on the CF’s price history), and we’re bullish about the fund’s investment focus, it may be a good time to buy the fund. For example, if we’re bullish metals, we’re looking for a CF that invests in Gold, Silver, etc. and is trading at an historically high discount.  

Our edge comes from having two opportunities to profit: first, as the underlying metals increase in value, the CF will increase in value, and second, the CF will increase in price on a relative basis as the discount returns to more average levels. 

For example, let’s say we buy a CF that invests in Silver. The fund’s NAV is $10, and it is trading at a 15% discount or $8.50. Also assume that the historical discount is 5%. If Silver rallies 20% and the discount returns to historical levels, we get a double whammy. We expect the CEF’s price to increase by about 20% based on Silver’s rally and the CF’s price would increase by another 10% as the discount returns to more normal levels – quite the edge.