High Volatility in Precious Metals Creates Excellent Arbitrage Opportunities! A $10 Billion Fund Shows a Large Discount

Intense volatility in the precious metals market is creating some unusual anomalies for gold and silver investors, which could represent an opportunity for “treasure hunters.”

Despite strong fluctuations in spot prices, some precious metals investment products have failed to keep pace. The closed-end physical precious metals fund with $10 billion in assets — the Sprott Physical Gold and Silver Trust (CEF) — traded last Friday at a 9.5% discount to its net asset value (NAV). On January 30, gold and silver suffered historic daily drops of over 11% and 31% respectively; however, on Tuesday both precious metals rebounded strongly, demonstrating that market volatility has reached extremely high levels.

In fact, when precious metals prices peaked on January 28, the fund’s discount was even larger, reaching a record high of 11.4% relative to its closing NAV that day.

The fund’s holdings are composed entirely of physical gold and silver stored at the Royal Canadian Mint, along with a small amount of cash, and its net asset value is updated daily based on market prices.

It is normal for closed-end funds to trade at a discount to their NAV, but the recent discount level of CEF is extraordinary. Since its inception in 2018, the average discount has typically hovered around 4%. By Monday, the discount had narrowed to 7.2%.

It is still unclear why the discount widened recently. The only evident correlation is that the widening of the discount coincides exactly with the recent increase in gold and silver price volatility. And deciphering the logic behind the recent price movements of both metals is in itself extremely complicated.

The current scenario could be creating ideal conditions for investors interested in executing pairs trades.

As of the end of last year, the fund’s portfolio, calculated by market capitalization, was approximately 59% gold and 41% silver. The fund trades on NYSE Arca and the Toronto Stock Exchange, with a fee of 0.48%.

Of course, there is no guarantee that prices will converge as expected; this type of trade is complex and carries costs associated with short selling. The real difficulty of exploiting price deviations through arbitrage may be the reason why these market anomalies persist. The evolution of these anomalies could be even stranger, and their duration, much longer than anticipated.

For common investors who wish to take advantage of a drop in precious metals prices but are not interested in complex arbitrage operations, buying a discounted closed-end physical precious metals fund offers additional profit potential compared to traditional gold or silver ETFs: if the discount narrows in the future, their final return could increase.

Sprott did not respond to requests for comment. The company notes in its disclosure documents that, since the number of shares outstanding is fixed at any given time, the fund’s trading price may trade at a premium or discount to NAV depending on investor demand. Fund shareholders have the right to request monthly physical redemption, but this right only applies to investors who meet the minimum redemption amount requirement. According to Sprott, this mechanism typically helps reduce the discount, although recently it seems to have had little effect.

Other Sprott physical precious metals closed-end funds have also experienced a widening discount.
The Sprott Physical Silver Trust (PSLV), with $17 billion under management, closed last Friday at a 9.4% discount to NAV, when four days earlier it was only 1.7%. On Monday, the discount narrowed to 4.9%.
The Sprott Physical Gold Trust (PHYS), with $18 billion under management, closed last Friday at a 4.1% discount to NAV, when four days earlier it was 1.2%. On Monday, the discount narrowed to 3.4%.

Whatever the cause behind the volatility in discounts, these phenomena remind investors that: