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.

Way back in May 2008 I wondered: Will Sprott IPO Mark Top Of Commodity Bull Market?

Yes. Yes, it did.

For those unfamiliar with them, Sprott is a boutique asset manager in Canada. The IPO of Sprott was an accurate tell for the commodity market top because of the firms expertise in and their cheerleading of the commodities markets.

You had to ask yourself this simple question: If they believed that the bull market in commodities would continue, why would they sell such a highly leveraged asset as their equity?

The dashed line is the CRB Index, the most popular measure of the commodities markets and the solid line is the price of Sprott (SII) on the Toronto Stock Exchange. It closed the first day at around $10 a share but fell immediately. It approached that high again to put in a double top and started to fall in lock step with the CRB index. In mid-November 2008 it traded below $2.50 - less than a 25% of the IPO initial price.

Another case of watching what others are doing and not necessarily saying. In general, you want to always be wary of whatever Wall St. sells. They aren’t doing it out of the kindness of their hearts or to be charitable.

This market ‘tell’ was one of the reasons why I was bearish on commodities and for the most part it was the right posture. The only exception lately of course has been the gold market which has surprisingly revived to once again gain the $1000/oz. level. I’ll come back to the gold market another time since it deserves more attention.

Sprott, a young Canadian asset management firm, is going public next week. This might be a market tell. Or it may be nothing.

The reason why I bring it up is not because of Sprott’s size or significance to the market. It is after all tiny, managing only $7 Billion - in the world of asset management that doesn’t even register as a blip on the radar.

Rather, it is that Sprott has been at the forefront of the commodity boom, riding the rise of oil, gas, and even obscure natural resources like molybdenum to earn management fees. The owner and main portfolio manager, Eric Sprott, is an unapologetic believer in “peak oil” and a huge gold bug.

What makes me question the IPO is its potential significance as a market tell for the whole commodity boom. There is no question that Sprott is an astute manager and market timer. The track record of his various funds attests to that. The natural corollary is then, why is he selling now?

If he thought that the commodity boom would be continuing or even accelerating, wouldn’t he want to keep as much of the company and the profits for himself?

The only logical reason to sell is if the commodity boom is about to come to an end.

Consider these other examples:

Sam Zell, probably the keenest real estate investor today, sold Equity Office Properties in February 2007 to Blackstone after a protracted bidding war between the winner and Vornado REIT. You get one guess on when the REITs in the US topped out.

Or take the June 2007 IPO of Blackstone Group (BX), one of the largest private capital managers in the US. Timing when to take companies public, when to take them private, and valuation is their bread and butter. Do you think they might know something you don’t?

Blackstone’s IPO marked not only its own share price but also the top for private equity deals:

For more examples, check out: Don’t buy what Wall St. sells

Of course that doesn’t mean that by default all IPOs are to be shunned. But in the case of Sprott there is a more fundamental reason. It is extremely expensive! The IPO values Sprott Asset Management at $1.5 Billion - twice as much as other Canadian boutique asset managers. Finally, Sprott is selling right at the top. The TSX is at a triple high above 14,500 and the energy sector is rather stretched to the upside as well.

Given the cyclical nature of the natural resource sector, my hunch is that sooner rather than later this sector will revert to the mean. Peak oil is a meaningless concept that has been bandied about for the past 50 years. Every time oil prices go up it finds a new following and every time oil prices return to earth the peak oilers somehow melt into the scenery quietly. The reason why Hubbert’s theory has been proven wrong again and again is that new advances in science and engineering processes move the line in the sand. In effect making it an anachronism.

In any case, for those interested, watch for Sprott’s IPO on May 15th. It will trade under the symbol SII on the Toronto Stock Exchange.