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Metals Premiums and Discounts: A Matter of Timing

Premiums do not necessarily indicate that you are overpaying for exposure.

Abraham Bailin, 08/24/2011

Fear and uncertainty abound in today's markets, renewing interest in precious-metals exposure. This leads, yet again, to questions about the reliability of the most popular offerings. At the center of this discussion sit physically backed precious-metals products like SPDR Gold Shares GLD and iShares Silver Trust SLV, which consistently swing large premiums and discounts to spot prices.

In the wake of early August's substantial correction, GLD and SLV developed discounts as large as 1.79% and 7.25%, respectively. Given the numerous inquiries that we have fielded, we are compelled to address the issue here.

Premiums and discounts for physically backed precious-metals offerings are not typically an indication of an under- or overvaluation. They are the byproducts of disjunctions between the timing of net asset value calculations and market price trades.

A Look at the Data
Concerns about significant premiums and discounts are not unfounded. We consider the total cost of ETF ownership to extend beyond mere management fees. Investors should carefully consider the impacts of both bid-ask spreads and premiums and discounts. By nature, they are costs that can easily surpass the expense ratio as the primary drag on returns over shorter holding periods.

For most traditional equity ETFs, premiums and discounts are generally mild. It isn't unreasonable to expect these funds to see daily deviations from NAV lower than 10 basis points. For the year to date, the average absolute daily deviation from NAV for SPDR S&P 500 SPY has been a mere 2 basis points. This being the case, we advise against purchasing a traditional equity ETF while it trades at a substantial premium. For the more exotic offerings, such tight tracking is not the norm, though it should not dissuade investors from participation.

Shifting our gaze from domestic large-cap equity to fixed-income, international, and commodity-focused exposure, we find that premiums and discounts widen significantly. Across the ETF universe, physically backed precious-metals offerings consistently suffer some of the largest premiums and discounts to their NAVs. For the year to date, SPDR Gold Shares' average absolute daily deviation from its NAV was roughly 44 basis points. IShares Silver Trust averaged a whopping 170 basis point daily deviation.

Such sizable disjunctions raise serious concerns about the reliability of these vehicles' pricing. Further, they can present investors with the illusion of under- or overvalued access to the asset class. On Aug. 4, SLV closed at a 7.25% discount to its net asset value. Opportunistic investors looking to establish a silver position may have found the scenario quite enticing, assuming that the ETF traded at some price below the value of its bullion holdings. The well-informed would have understood that the circumstances were most likely created by a simple time lag.

NAV and Closing Market Price: Snapshots in Time
To understand why physically backed precious-metals offerings suffer the most significant price dislocations, one must first understand how a premium or discount is calculated.

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