Trader’s Narrative

As gold bullion made a third attempt at the round number $1,000 there is a rush to feed a seemingly insatiable demand for gold securitization:

The most recent related IPO was the Claymore Gold Bullion Trust (CGL.un) on the Toronto Stock Exchange. Claymore is a small but innovative Canadian based asset manager and they’ve created a unique product. For starters, the fund will hedge almost all of its currency exposure to the US dollar. So Canadian investors will hold gold in Canadian dollars, not against the US dollar. Second, although structured as a closed end fun initially, if there is a persistent discount to NAV, it will convert to a ETF at the NAV (and therefore, eliminate discounts/premiums that plague all CEFs).

The Claymore Gold IPO was oversubscribed ($460 million Cdn) with over half being taken by large institutions. What really made Claymore’s product attractive to US institutions especially is the different in taxation schemes. By investing in an ‘offshore’ security, US investors can avoid the 28% luxury tax they would normally have to pay for holding gold and instead pay a much smaller 15% tax rate.

In the end, I can’t help but remember what we should have learned long ago: Don’t Buy What Wall St. Sells.

So is Claymore’s Gold IPO a signal for a top in gold?

Consider that the Claymore Gold CEF (probably ETF in due time) joins a quickly crowding field. Sprott Asset Management launched their Sprott Gold Bullion Fund, an open ended mutual fund earlier in the year. These join the existing two gold funds: the Central Fund of Canada (CEF) and Central Gold Trust (GTU) - both of which took advantage of the appetite for gold to raise $200 million each via a secondary offering last month. Even more interesting, the secondary offerings for both of the existing gold CEF’s were done at premiums to NAV.

But all of these funds pale in comparison to the SPDR Gold Shares ETF (GLD), which believe it or not, holds more gold than the Swiss central bank.

Those who bought this IPO placement (Thursday May 28th, 2009) from their brokers at $10 were immediately underwater:

Right now there is a small discount to NAV and the only consolation is that Claymore will convert from a CEF to a ETF if it persists for a few more months. But of course, the value of gold will play a much more important role in whether this was a smart investment or not.

Remember that last year Sprott flagged the top of the commodity bull market by issuing their own IPO. If we’ve learned anything about market timing, it is that when the ducks quack, Wall St. feeds them.

Last month I outlined a strategy using closed end funds to take advantage of the January effect in the stock market. The opportunity came and went, so here’s a brief review with a few specific examples.

In order to give you the right idea, lets start with a good example to show the pattern we’re looking for. The BlackRock Minicipal Bond Fund (BBK) is a great example of the setup:

Notice how it dropped right into the technical support previously found in mid October? That, along with the volume spikes in early December, make this a great example. As prices lifted off into the new year, it was attracted to the swing high which acted as resistance - making it a natural place to scale out (red arrows).

Here’s another example with an equity CEF, the RMR Dividend Recapture Fund (RCR):

I’ve highlighted the low volume because can be problematic if you step in with size and don’t use limit orders. Otherwise you’d do fine and pocket a +60% return. Even if we assume that you were able to squeeze out half of that, considering slippage and trading costs, etc. you are still looking at an astronomical annual rate of return.

Finally, I also wanted to show a less than perfect example to make sure that you don’t mistake this strategy as a sure thing:

I stayed away from this one because it isn’t a municipal bond fund but if you played it, it was difficult to come out unscathed. On the plus side, the loss was very small. But it serves as a reminder that even with a high probability setup like this one, you can’t ignore risk completely.

If you want to see even more example, take a look at My Year-End Strategy.

There a few ways to take advantage of the January effect this year:

Small & Micro-Cap ETFs
The simplest would be to buy small cap stocks or ETFs before the year end and hold until they have a pop. Since the definition of “small-cap” has been continuously revised up over the past few years, it might be a good idea to look at “micro-cap” stocks. Here are a few ETFs:

• iShares Russell Microcap Index (IWC)
• First Trust Dow Jones Select MicroCap ETF (FDM)
• Powershares Zacks Micro Cap Portfolio ETF (PZI)
• Powershares Dynamic OTC Portfolio ETF (PWO)
• iShares S&P SmallCap 600 Index Fund (IJR)
• iShares Russell 2000 Index Fund (IWM)
• iShares Morningstar Small Core Index Fund (JKJ)
• SPDR DJ Wilshire Small Cap ETF (DSC)
• Vanguard Small-Cap ETF (VB)
• PowerShares Dynamic Small Cap Portfolio (PJM)
• PowerShares Zacks Small Cap Portfolio (PZJ)

Closed End Funds
Last week I mentioned a method to capture January effect alpha which uses CEF and specifically, municipal/bond CEFs. This year is a bumper crop for this specific strategy because of the vast number of these funds which have severe losses.

Value Line Futures Index
Yet another way to play the January effect is to use the Value Line Arithmetic Index futures. This is a little known equity index compiled by Value Line Inc. - the investment research outfit. It is comprised of approximately 1,650 stocks which are equally-weighted, as opposed to capitalization weighted as in the S&P 500 Index.

The futures for this index are traded at the Kansas City Board of Trade with each contract valued at $25 times the value of the index (appx. 1324). The Value Line January effect strategy is pretty straight forward:

Buy the Value Line contract (nearby month of course) and (sell short) equal value ratio of the S&P 500 Index. Close the position in the first week of January. Depending on the calendar, around the 9th of the month. That’s it.

This simple spread trade has a remarkably high profitability ratio but sadly it only comes once a year. And the advantage it has to the other two year end strategies is that it is market neutral. Although I suppose you could short SPY to offset a long position in small/micro-cap ETFs.

As this annus horribilis draws to a close, we are left ducking shoe after shoe that drops or is flung at us. But this year’s abysmal performance has a silver lining. It offers a sumptuous buffet for those who finish off the year with a play on the January effect.

For the novice, this is the trading pattern at the end of the year which the efficient market hypothesis says shouldn’t even exist. Usually it is small or micro capitalization stocks which have declined and are then pushed down further by tax-loss selling. The opportunity is to play these for a short term bounce into the new year.

Personally, I focus on closed end funds (CEFs) and within them usually fixed income or municipal bond CEFs. I go into great detail explaining the background, rationale and several actual trades: My Year End Strategy

I won’t repeat myself because you can get all the info you need from the above link. This is a very high return, high probability trade but it depends on how poorly the target securities have fared.

This year, I feel like a kid in a candy store. While this abundance is great, it does make it a bit more challenging to filter all the potential plays and find the best ones.

You can sift through the CEFs through a publication like Barron’s which not only prints their prices but also their year to date performance and premium/discount to NAV. Online you can use the CEF Association’s database or check out ETF Connect and use their Fund Sorter or do an advanced search to only look at certain sub-sections of securities like municipal bond fund CEFs.

Here’s an example of the sort of securities to choose from:

Continue reading ‘How To Play The January Effect This Year With CEFs’

Well, it is the end of another year. And if you are a trader, your thoughts turn invariably to the January effect and more specifically, how you can use this phenomenal annual pattern to generate alpha.

There are a few ways to take advantage of the January effect. My personal favourite is on closed-end funds (CEFs). I’ve outlined the whole trading plan here: My Year-End Strategy.

With the turmoil in the bond market this year, a lot of bond funds and other “yield” vehicles have gotten beaten to a pulp. Which means there are a lot of unhappy longs who are selling for tax-loss year end reasons.

I feel like a kid in a candy store this year.

I’ll just feature one example: BlackRock Municipal Bond Fund (BBK), but for a vowel, my namesake. Almost everyone who bought this this year is facing losses:

Notice the upsurge in volume - a telltale sign. And the way it has fallen to technical support at $14.

Hope you had a great year, and see you in 2008