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Commodity Price Drop Creating CEF Bargains

Jeremy Glaser
Cara Esser, CFA

Jeremy Glaser: For Morningstar, I’m Jeremy Glaser. The recent fall in gold and other precious-metals prices has put a spotlight on commodity funds. I’m here with Cara Esser. She is a closed-end fund analyst. We are going to look at how closed-end funds that hold these precious metals have performed.

Cara, thanks for joining me.

Cara Esser: Thanks for having me.

Glaser: So, let’s get the broad overview. How many closed-end funds are there that track precious metals and track other commodities, and how are they generally structured?

Esser: There are five closed-end funds that track precious metals, in particular. And so they’ll either hold gold, silver, platinum, or palladium, or some combination of the metals themselves. And there are also two funds that invest in the equities of firms that are investing in commodities and natural resources and precious metals. So, if you are interested in the underlying equities as opposed to the actual commodities, there are two funds out there that do that, as well.

And it’s interesting to note that the largest closed-end fund in existence is a commodities closed-end fund. The ticker is CEF. It’s called the Central Fund of Canada, and it is a gold and silver fund.

Glaser: What are the fee structures on these? Why would you chose these over, say, GLD or one of the exchange-traded funds that track precious metals?

Esser: So the funds that track the precious metals themselves actually have very competitive fees related to the ETFs. Most of them are less than 50 basis points, and that’s right about in line with the ETFs.

Glaser: Then what are the distribution rates?

Esser: They generally do not have distribution rates. The exception being the equity funds that invest in the underlying equities of the firms--they do have distribution rates. But because the precious metals themselves are obviously not giving you any income, it’s unusual for a closed-end fund to have a 0% distribution rate, but none of these distributes any capital gains or income.

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Glaser: So, when you look at your rating for these funds, do you think that they are good ways to track these precious metals if you’re interested in getting that exposure?

Esser: We have ratings on three of the commodity-based funds, and two of them are actually rated Bronze, which is a positive rating. Those funds are CEF, the largest closed-end fund in existence; and GTU, that’s a gold-focused closed-end fund. And we like these funds because they do track the underlying commodities quite well. In addition, the fees are very low.

Glaser: So, those are the two major factors that come into rating these funds?

Esser: Yes. We wanted to pay attention to the tracking error, because that’s obviously very important. There are so many other choices out there when you are looking at gaining access to commodities, and fees are, obviously, very important because you can get an ETF that’s incredibly inexpensive.

Glaser: So, with this big fall-off, in particular with gold prices, but also some of those other commodities, what does that mean for the performance of these funds, and where do you think valuation levels are right now?

Esser: This is where closed-end funds get a little bit interesting because the underlying net asset value of this commodity-based funds have basically fallen in line with the ETFs in the broader commodities market. So, there is nothing too exciting there. However, the share price has fallen a lot more quickly than the underlying net asset value. So, we have seen a dislocation in share price, which means the discounts are widening and there are some funds that are selling at advantageous discounts.

Glaser: What would be some of your top choices right now?

Esser: Some of the funds that are undervalued on a one- and three-year statistical basis right now would be CEF and GTU.

Glaser: So these look undervalued. Does that mean that they are now core holdings in your CEF portfolio, or should they be seen more as satellite holdings?

Esser: Any kind of precious-metals holding, whether it’s a closed-end fund or whether it’s an ETF should be a small part of a well-diversified portfolio.

Glaser: If you want these to be a small portion of your portfolio, what would the advantage of that be?

Esser: The advantage is diversification, so the commodities market generally doesn’t track the overall equity market or the fixed-income market for that matter. So, it’s a good way to diversify a portfolio if you are worried about inflation. Some people think that commodities can be a good hedge against inflation, but again you always want it to be a very small part of your portfolio.

Glaser: Cara, thanks for your thoughts today.

Esser: Thanks.

Glaser: For Morningstar, I’m Jeremy Glaser.