Category Archives: Special Situations

Yes, There are Good Stockpickers (VIC)

Ted Talks

Evidence suggests the professional investors in my sample have significant stock-picking skills. Interestingly, these skilled investors share their profitable ideas with their competition. I test various private information exchange theories in the context of my data and determine that the investors in my sample share ideas to receive constructive feedback, gain access to a broader set of profitable ideas, and attract additional arbitragers to their asset market. The proprietary data I study are from a confidential website where a select group of fundamentals-based hedge fund managers privately share investment ideas. The investors I analyze are not easily defined: they exploit traditional tangible asset valuation discrepancies, such as buying high book-to-market stocks, but spend more time analyzing intrinsic value and special situation investments.

Can Investors Pick Stocks on VIC 01272010-Wesley Gray

VIC

Bubble in Safety? http://intrinsicinvesting.com/2016/08/24/wd-40-a-case-study-of-the-bubble-in-safe-stocks/

Special Situation Quiz Question; An Overcrowded Trade

collection

 Rags make paper,
Paper makes money,
Money makes banks,
Banks make loans,
Loans make poverty,
Poverty makes rags.
-Anonymous

Interview at Special Situations Hedge Fund

You have been working so hard to have an interview with Buffo and Greensplat Special Situations Hedge Fund and now you are in their offices.   The interviewer sits down and then asks, “Can you please tell me what you think was the greatest special situations trade/investment of the past thirty years and what was the catalyst for the trade?”  Hint: This made huge multiples on the original capital.  Few recognized the opportunity until too late.

An overcrowded trade in the search for yield. http://truecontrarian-sjk.blogspot.com/

Tuesday, August 2, 2016

THE FIRST AND THIRD SHALL BE FIRST, WHILE THE SECOND SHALL BE LAST (August 1, 2016): There is a fascinating pattern to the trading during the first seven months of 2016. The strongest sectors by far have exclusively been silver and gold mining shares, in that order, followed primarily by other commodity producers and mining-related emerging-market equities. The second-biggest percentage winners have mostly been high-dividend, low-volatility assets including consumer staples, utilities, REITs, tobacco shares, telecommunications companies, and long-dated U.S. Treasuries. The third-best performers of 2016 have been mostly energy companies and a variety of emerging-market stocks and bonds.
This is puzzling is because the first and third groups are inflation-loving assets, whereas the second group performs well when deflation reigns. How can the financial markets be both inflationary and deflationary?
The deflation trade is nearly over, but it has remained in a bull market due to huge inflows from investors desperate for yield.
High-dividend and low-volatility assets including FXG and XLP (consumer staples), IYR and RWR (REITs), XLU, IDU, FXU, and VPU (utilities), along with TLT and ZROZ (long-dated U.S. Treasuries) have been among the second-best performers of 2016. They have also been among the top winners of the past five years. Many of those who have retired or who need to pay their monthly expenses have become overly dependent upon income-producing investments to generate yield. That’s fine as long as high-dividend assets are either bargains or reasonably priced, but it creates a dangerous situation when they are trading at all-time highs even compared with previous historic peaks. There have been all-time record inflows into high-dividend and low-volatility funds which have far outpaced their previous records. A person who has retired with a half million or a million dollars might perceive that he or she “needs income” in order to maintain a basic lifestyle, and most of these investors don’t realize that if everyone goes to their financial advisors and wants the same level of “safe” income then they are all going to end up owning the exact same assets. What would be reasonable for a tiny minority of investors has become an inevitable catastrophe since millions of others are acting similarly without realizing the consequences of collectively being in such an overcrowded trade.
The inflation trade has only been in a bull market since January 20, 2016, and has a long way to go to recover its losses since April 2011.
Unlike most high-dividend assets which had bottomed in the first quarter of 2009, most commodity producers and emerging markets had been in severe downtrends from April 2011 through January 20, 2016, and even after their subsequent strong rebounds remain far below their previous peaks. Earlier this year, many of these assets completed multi-decade nadirs, with some of them touching levels not seen since the 1970s. Therefore, they remain substantially below fair value. Silver and gold mining shares including GDXJ, SIL, GLDX, SILJ, and GDX have tripled on average in just over a half year, and have thereby outpaced nearly all energy producers which had initially rallied but have gone out of favor along with most emerging-market equities during the past several weeks. This has created the best bargains for those assets which are in the process of completing important higher lows including URA (uranium), GXG (Colombia), FCG (natural gas), and FENY, a more diversified and less volatile fund of energy producers.
The Daily Sentiment Index for crude oil, indicating the percentage of traders who are bullish toward any asset, plummeted to 10% at the close on Monday, August 1, 2016. This is an incredibly low level for anything which is in a primary bull market, as energy commodities have been since February 11, 2016. The shares of energy producers mostly approached or reached multi-decade bottoms on January 20, 2016. Whenever it is possible to buy at higher lows during a major uptrend, this is ideal because a sequence of several higher lows is often followed by an accelerated rally.
The high-dividend and low-volatility bull markets are very stale and incredibly popular, while few know about the uptrends for commodity producers or emerging markets.
Almost everyone knows that high-dividend shares have been the biggest winners of the past several years and are still eager to jump aboard the bandwagon, while few realize how overcrowded this bandwagon has become. Historically, the most wildly trendy and popular trades have always proven to be disappointing. Although it is rarely compared with the internet bubble of 1999-2000, the Nifty Fifty overvaluation of 1972-1973, or the blue-chip top of 1929, high-dividend and low-volatility names have become the bubble of the decade. The total assets in USMV, a frequently-touted low-volatility fund, have tripled in one year. Just as in 2000, almost no one who has invested in these securities realizes that they can lose half or more of their money. Almost no analysts, even those who know how overvalued these popular securities have become, can emotionally imagine them plummeting. They might know intellectually that it is possible, but they can’t really imagine it happening any more than anyone at the beginning of the century could envision the Nasdaq plunging by more than 75% within three years. Alas, a similar fate awaits those who are participating in high-dividend and low-volatility shares and funds.
Just because you’re in the water to get exercise doesn’t mean you can ignore the great white sharks.
When I point out the dangerous of owning high-dividend and low-volatility shares, I often hear the refrain that “I’m not in these due to their extreme popularity” or “I only own these to generate the income I need to pay my expenses.” The market won’t treat you differently just because your motivations are allegedly pure. You might be the nicest person on your block, you might generously donate to charities, and you might frequently help old ladies to cross busy streets. Even if you’re swimming in the water just to get your daily exercise, you’re not magically exempt from being eaten by hungry great white sharks that are lurking nearby. If any given trade has become desperately overcrowded, then no matter why you’re involved in it, you’re going to be as badly hurt as the ignorant buyer who is doing it to keep up with his poorly-informed friends. As Warren Buffett has stated, when we strip off the clothing and pretense, we’re all fully exposed underneath. When the U.S. housing bubble collapsed in 2006-2011, as it about to do again in 2016-2021, it won’t spare those who are nice to animals or who do good deeds. I will discuss real estate in more detail in the near future.

Surf the Lquidity; Gold Stocks

Nude

surf bigSurf the liquidity

Below is a link to six videos that analyze the global debt problem.  A good review of our monetary system and the current/impending problems. Do YOU agree with the analysis? Your thoughts welcome.

Santiago Capital: What Massive Debt Means…. http://play.pointacross.com/Player.aspx?gmid=866sfb2zve21

Gold Stock Update from Myrmikan Capital.

Myrmikan’s error in 2011 was an underappreciation of the forces the central banks brought to bear to reverse the credit collapse. Quantitative Easing was the least of the tools: it was the trillions of dollars of guarantees and the suspension of market-tomarket accounting that allowed the banks to puff the bubble even larger. And, there may remain policies that can lead into another round of even greater insanity, which would weigh on gold. Former Chairman Ben Bernanke, for example, recently traveled to Japan to educate them on “helicopter money.” According to Bloomberg, Bernanke suggested the government issue non-marketable, perpetual bonds with no maturity date and that the Bank of Japan directly buy them.

Read more Performance_Update_2016_06

Coal’s Sunset/The Capital Cycle; Graham Bangs the Table

millenniumforce02wide

http://csinvesting.org/2016/01/13/more-on-the-capital-cycle/ was our last discussion on the capital cycle.

Coal_Haul_Truck_at_North_Antelope_Rochelle

Now, look at these two excellent posts on Coal.

A perspective on current conditions in other markets:

The Big Long – Final Feb 28 2016 The writer promises a follow up to discuss catalysts–which, I believe, will be the change in supply and demand dynamics and the capital cycle. See article referred to here: 2_Buffett and Graham Call the 1974 Market Bottom

and for more historical and emotional perspective:

 

SEARCH STRATEGY: Announced Cash Liquidation

Sunridge Gold Corp. (SGC:TSX.V; SGCNF:OTCQX), which has a project in Eritrea that is getting sold to a Chinese entity. On a per share basis a shareholder will get about $0.35/share in cash or more payable in two tranches. It was trading at about $0.28/0.29 today in early February, and that offers about 30% upside.  The deal has been voted on and accepted. See terms announced here:

http://www.marketwatch.com/story/sunridge-receives-shareholder-and-warrantholder-approval-to-sell-sunridges-60-interest-in-asmara-mining-share-company-and-distribute-proceeds-2016-01-22?siteid=bigcharts&dist=bigcharts

The above is only for individual special situation investors. A miner in Eritrea!

Follow the Capital Cycle as a Contrarian

Stanley

Ed Chancellor on the capital cycle…

From his introduction to Capital Returns: Investing Through the Capital Cycle: A Money Manager’s Reports 2002-15, which was released in hardcover today (Dec. 2015):
Typically, capital is attracted into high-return businesses and leaves when returns fall below the cost of capital. This process is not static, but cyclical – there is constant flux. The inflow of capital leads to new investment, which over time increases capacity in the sector and eventually pushes down returns. Conversely, when returns are low, capital exits and capacity is reduced; over time, then, profitability recovers. From the perspective of the wider economy, this cycle resembles Schumpeter’s process of “creative destruction” – as the function of the bust, which follows the boom, is to clear away the misallocation of capital that has occurred during the upswing.

The key to the “capital cycle” approach – the term Marathon uses to describe its investment analysis – is to understand how changes in the amount of capital employed within an industry are likely to impact upon future returns. Or put another way, capital cycle analysis looks at how the competitive position of a company is affected by changes in the industry’s supply side. In his book, Competitive Advantage, Professor Michael Porter of the Harvard Business School writes that the “essence of formulating competitive strategy is relating a company to its environment.” Porter famously described the “five forces” which impact on a firm’s competitive advantage: the bargaining power of suppliers and of buyers, the threat of substitution, the degree of rivalry among existing firms and the threat of new entrants. Capital cycle analysis is really about how competitive advantage changes over time, viewed from an investor’s perspective.

  1. Follow the capital cycle as a contrarian (well worth STUDYING!)
  2. Gold miners in the capital cycle (part 2)

http://www.marathon.co.uk/global-investment-review.aspx (Read several articles on the capital cycle in investing).

Watch for errors  (Interview of the gentleman pictured above)

Contrarian Dream or Nightmare?

SPX to CRB

You can see the parabolic move to extremes. Extremes can become more extreme, but what can’t continue will end.  Commodities are at forty-year extremes. Prices will go low enough to shut down the high cost producers until the price settles near the lower part of the cost curve.  Supply is shutting down in zinc and uranium, for example.   Financial assets will not be bid up to infinity despite the price charts for AMZN or IBB.

crblongterm131215

For further perspective:

CRB 2 centuries

The CRB index is printing 174 or not since 1975 have we seen such prices. Consider that Nixon severed the dollar’s link to gold in 1973 which caused nominal prices to rise.  The current bust is the flip-side of the massive mal-investment caused by ZIRP and easy credit over the past several years. the bust is the cleansing of the boom.

What will happen now? 

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” Ludvig V. Mises.

Mises is saying that if the government abandons its credit inflation, then there will be a total credit collapse (probably causing deflation or debt destruction). Or the government can increase and persist in its credit inflation leading to a crack-up boom/currency collapse.

The Fed is presently heading down the inflation path, but it doesn’t have to stay on this path. A change of direction is still possible.

Now for the other Mises quote:

This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices, although the extent of this rise will not be the same in the various commodities and services. These people still believe that prices one day will drop. Waiting for this day, they restrict their purchases and concomitantly increase their cash holdings. As long as such ideas are still held by public opinion, it is not yet too late for the government to abandon its inflationary policy.

But then, finally, the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against ‘real’ goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.”  –Mises

The gist is that if the inflation policy continues for long enough then a psychological tipping point will eventually be reached. At this tipping point the value of money will collapse as people rush to exchange whatever money they have for ‘real’ goods. Mises refers to this monetary collapse as the “crack-up boom”. Prior to this point being reached it will not be too late to abandon the inflation policy.

Today, the US is still immersed in the first stage of the inflationary process. If it continues along its current path then a “crack-up boom” will eventually occur, but there is no way of knowing — and “Austrian” economic theory makes no attempt to predict — when such an event will occur. If the current policy course is maintained then the breakdown could occur within 2-5 years (it almost certainly won’t happen within the next 2 years), but it could also be decades away. Importantly, there is still hope that policy-makers will wake up and change course before the masses wake up and trash the currency.

In conclusion, “Austrian” economic theory helps us understand the damage that is caused by monetary inflation and where the relentless implementation of inflation policy will eventually lead. That is, it helps us understand the direct and indirect effects of monetary-policy choices. It doesn’t, however, make specific predictions about whether the next few years will be characterised by inflation or deflation, because whether there is more inflation or a shift into deflation will depend on the future actions of governments and central banks. It will also depend on the performances of financial markets, because, for example, a large stock-market decline could prompt a sufficient increase in the demand for cash to temporarily offset the effects of a higher money supply on the purchasing power of money.

The upshot is that regardless of how the terms are defined, at this stage neither inflation nor deflation is inevitable.   http://tsi-blog.com/2015/07/does-austrian-economics-predict-inflation-or-deflation/

…Back to being a contrarian.  As a contrarian you don’t reflexively buy plunging prices, but you do look for ugly, distressed and cheap where there is a high level of fear and dislocation because you are more likely to find mis-pricings. –Prof. Greenwald.

Are coal stocks a buy?  They are likely to finish 2015 down a whopping 5 years in a row, along with another hated sector, gold stocks.  Both are down over 80% from their peak.

I’ve written a lot about reversion strategies on this blog (Meb Farberand my books.   It is always hard to try and decide when an investment has declined and is a true value, or when it has simply declined with more to go?  There are lots of famous investing quotes to use here that may or may not be funny depending on your current holdings.

“Buy when there is blood in the streets”

“What do you call a market down 90%?  It is a market that was down 80%, and then got cut in half from there.”

“Investing is the only business that when things go on sale, everyone runs out of the store”

“You want to be greedy when others are fearful. You want to be fearful when others are greedy.”

Ironically, the only industry to ever print 6 down years in a row?

Coal stocks. (ending 1933)

coal

You can see the chart here and how it set the stage for great future returns…but it wasn’t until the early 1940s before they really started their bull run…

The next post will describe investing in cyclical stocks.

Gold Stocks: No One Left to Kill?

5-Gold-sentiment-1

An Interesting Juncture for Gold Stocks (A good read with links)

Note that CEF in the above chart trades at an 11% discount to its 60%/40% holding of gold and silver bullion after a four year down-trend–note that this is either hyper-bearishness or massive extrapolation of trend-following.   Apple’s cash hoard could buy the entire public mining sector.   Gold stocks are cheap for a reason: poor capital allocation, poor cost control, and dilution of shareholders revealed in the five-year long bust from an epic boom from 2001 to 2011 caused investors to flee.   Since then many managements have gained religion on cost control and capital discipline (Note Barrick, ABX). All cycles turn, but when? If we knew, then no opportunity.

I always hear investors or analysts ask, “So what is the catalyst?”  If the market is at all efficient–and I would say that it is except at major inflection points–then if we knew the catalyst, then the opportunity would be arbitraged away.  How about the law of low prices or the law of supply and demand.

gold_GNX_231115

Ironically, as gold has declined in US dollar terms, it has risen in real terms versus commodities showing its mettle in a credit contraction.  TSI BLOG

1-Divergences-complete-772x1024The HUI, a gold stock index, is showing relative strength versus gold.   However, certain gold stocks like Novagold (NG), Sabina Gold (SGSVF) or Agnico-Eagle (AEM) are in incipient uptrends or, at least, vastly outperforming their indexes such as GDX or GDXJ.  You must diversify amongst the highest quality producers, developers, and explorers.

This post is not a recommendation but a historical reference point for a hated asset class.  I see much less RISK in a terrible industry such as gold mining than wonderful businesses such as Amazon, CRM, or GE.

Valeant Case Study in Progress

wisdom

There is an ongoing battle over Valeant’s (VRX) valuation and business model between short-sellers and investors.   This opportunity allows us to improve our analysis skills and understanding of business models.  Also, how will Sequoia, an owner of over 20% of Valeant’s equity, handle their portfolio?

My first question is whether Valeant is a franchise with durable competitive advantages or a roll-up of commodity products dressed-up in a fancy industry (Pharma)?   We should use this case to learn how experienced analysts present their opposing views.

First: What’s not to like?  Valeant has rapid growth with huge profit margins? Of course, the PERFECT investment is a company that has high returns on capital and can constantly redeploy its capital at the same high returns.  The classic case would be the early (pre-2000) history of Wal-Mart (WMT) as the high returns generated from its stores could be redeployed into new stores on the borders of their regions which had economies of scale in administration, advertising, and management costs per unit of sales.  WMT did not have, for example, advantages in gross margins, but net profit margins. See WMT_50 Year SRC Chart.

What would be the source of Valeant’s high returns and competitive advantages?

Sequoia (a well-known value fund with an excellent long-term record) saw strong competitive advantages.  See their recent investor transcript:

Sequoia-Fund-Transcript-2015-August  Note the date of the transcript and the questions regarding Valeant concerning Philador and Sequoia’s 20% concentration.

Other investors (Charlie Munger, Citron) disagreed:

April 2, 2015 from www.fool.com

…..Recently, during a shareholders meeting for the Daily Journal Corporation, a newspaper where he serves as Chairman, Munger had this to say about Valeant Pharmaceuticals Intl Inc. (TSX:VRX)(NYSE:VRX): “Valeant is like ITT and Harold Geneen come back to life, only the guy is worse this time.”

What exactly does Munger mean by this?

A little history lesson

Who exactly was Harold Geneen? And what did he do at ITT that’s so infamous?

Geneen took over ITT Corp in 1959 when it was still mostly a telegraph and telephone company. After being blocked by the FCC in an attempt to buy the ABC television network in 1963, Geneen decided to diversify away from the company’s traditional business and completed more than 300 acquisitions during the decade in areas such as hotels, insurance, for-profit education, and the company that made Wonder Bread.

Geneen used cheap debt to finance these acquisitions, which later proved to be the company’s downfall. After Geneen’s retirement as CEO in 1977, subsequent CEOs spent much of the next two decades paying off the debt by selling most of Geneen’s acquisitions.

Is Valeant really comparable?

On the surface, Valeant looks like it could be pretty comparable to ITT. Since merging with Biovail in 2010, Valeant has made more than 30 different acquisitions, most of which were paid for with debt or by issuing shares.

Since the end of 2010, Valeant’s debt has skyrocketed from US$3.6 billion to US$15.3 billion. Shares outstanding have also gone up considerably from 196 million to 335 million. It’s obvious that Munger is onto something.

But on the other hand, I’m not sure Valeant is anywhere close to being as bad as ITT was. For one thing, all of the company’s acquisitions are at least in the same sector. ITT was buying up hotels and car dealerships, while Valeant is buying up pharmaceutical companies. Valeant’s efforts scale up a whole lot better than ITT’s ever did.

There’s also a bit of hypocrisy coming from Munger on this issue. Munger is actively involved in a company that does pretty much the same thing as ITT did back in the 1960s. Sure, Berkshire doesn’t use much debt or engage in hostile takeovers, but Berkshire and ITT have more in common than Munger is willing to admit. Both attempted to dominate the business world using a roll-up acquisition strategy; Buffett and Munger were just a little more patient with their plan.

But just because Munger exaggerates how bad Valeant’s acquisition spree has been doesn’t mean the stock is necessarily a buy at these levels. The company had earnings of just $2.67 per share in 2014, putting the stock at a P/E ratio of nearly 100 times. Yes, earnings are expected to grow substantially in 2015, but the outlook is simple. For the stock to continue performing, the company must continue to make acquisitions.

After making more than 30 acquisitions in just a few years, it’s hard to keep finding deals that will not only be big enough to make a difference, but will also prove to be good long-term buys. There’s so much pressure on management to keep buying that a serious misstep could be coming. If that happens, this hyped stock could head down in a hurry.

Although I don’t buy Munger’s alarmist concerns about Valeant, I agree with him on one thing. The stock just isn’t attractive at current levels.

A potential acquisition target, Allergan, Inc., points out its worries over Valeant’s business model. investor-presentation-may-27-2014-1 on VRX

Citron, a short-seller, attacks with a report: Valeant-Part-II-final-b. Valeant is another “Enron.”  Use the search box on this blog and type in Enron and follow links to review that case.  Enron never showed the profit margins that Valeant is currently showing.   NEVER take another person’s statement on faith.  Check it out for yourself. 

Valeant today (October 26th, 2015) counters Citron and answers investors’ concerns with 10-26-15-Investor-presentation-Final4 Valeant and video presentation:  http://ir.valeant.com/investor-relations/Presentations/default.aspxeep.

Ok, so what is Valeant worth?   Can you make such an assessment?  How do you think Mr. Market will weigh-in?   If you owned a 20% stake in Valeant, how would you manage the position?   What are the main issues to focus on?

This may be too difficult to analyze for many of us but we have  or will have many documents and reports to provide insights.  Remember that there are two sides to every narrative. Can we move closer to reality or the “truth”?

Note www.whalewisdom.com and type in VRX.   What type of investor owns Valeant?   Will momentum investors stick and stay?

Your comments welcome.

Sign up for Whitney Tilson’s emails on investing.  Worth a look: leilajt2+investing@gmail.com

Closed End Fund Arbitrage

Premium GTU to PSLV (Sprott)Premium

Discount GTU to PSLV

Discount

Closed End Fund Arbitrage and Hostile Takeovers

Our story begins with a closed end gold trust – GTU – that has been trading at a significant discount to its net asset value.   GTU, like its sister funds “CEF” (a mixed closed end gold and silver fund) and SBT.TO (a closed end silver trust), holds physical bullion in a Canadian vault.   Also, like its sister funds, it lacks a quality redemption feature – by which I mean: the ability to redeem units at their NAV (net asset value).   GTU’s redemption feature provides for redemption at roughly 90% of NAV.  Unlike an ETF,  a CEF (this might get confusing because we’re talking about Closed End Funds, but GTU’s sister fund actually has the ticker “CEF” also…) offers no way for market participants to create new shares: share creations must be done by the trust (they’d do an offering of shares and use the proceeds to buy bullion – if the units were trading above NAV).

When you account for the fact that GTU’s sector – precious metals ETFs/trusts/closed end funds – has been flooded with a variety of competing instruments which have superior redemption features, and that metals sentiment has been waning for a solid 2 years now, it’s not surprising that GTU had recently been trading at apersistent discount to NAV.

Enter:  Polar Securities, who purchased a stake in both GTU and SBT.TO, and then made an effort to get the Trusts to change their bylaws in such a way that would likely narrow the discounts to NAV that both trusts were suffering from.    Polar wrote a letter to unit-holders, and forced each board of directors to call a special meeting to vote on amending the bylaws.

None of this struck me as odd: this is something funds do all the time: buy cheap assets and try to unlock the value discounts that are present.   Amazingly, however, in goldbug-land, Polar Capital taking steps to try to close the massive discount to NAV that these two precious metals trusts were facing turned into cries of Polar attempting to “raid” the metal from the trusts.    While one might expect shareholders to be excited about the prospect of a narrowing of the massive NAV gap they’ve been languishing under, many instead rallied the wagons to fight this proposal!

GTU itself fought back, attacking the points of Polar’s proposal.  The GTU board of trustees noted that

1) Polar’s proposed redemption feature would be available to only a small number of holders, due to minimum size in the redemption requirement.   This is true, but largely irrelevant: all investors would benefit from a narrowing of the NAV discount if arbitrageurs came in to buy cheap GTU shares and redeem them to close the discount.  Although:

2) The board also noted the tax effects of redemptions, where the gains on sale of bullion would be taxable, and be borne by remaining shareholders.  This is true, but the effect would be miniscule compared to the massive discount to NAV that could be closed.

3) U.S. Mutual Funds may sell GTU to avoid these adverse tax consequences.  Reality suggests that GTU’s largest unit-holder, a U.S. based mutual fund, is eager to see the discount narrowed – but more on that later.

4) Polar’s proposal would increase GTU’s operating expenses.  Again, this is true, but we’re talking about matters of basis points – not percentage points that could be gained by the adoption of the proposal and closing of the massive NAV discounts.

So Polar replied with a PR of their own, repeating that the Trustees had no means of closing the discount and no plan to do so.  A common refrain you’ll hear from holders of GTU is something like: “when the price of gold is going down, GTU trades at a discount to NAV. When the price of gold goes back up, the discount will narrow.”

Well: *maybe* it will narrow – or maybe the market has been saturated with superior competing products that have equal “safety” and pareto-superior redemption features that can actually insure that discounts to NAV will be closed.  GTU lacks these features, and thus there is no reason why the discount must close if/when the price of gold rallies.  As I noted in a past post, just because a closed end fund traded at a premium in the past doesn’t mean it will/should trade at one again in the future, *especially* when there are a plethora of other ways to get the same exposure with other products.

Anyway, GTU responded to Polar’s latest PR quickly, noting:

1) Polar is not aligned with long term holders of GTU – I don’t know what this means: Polar wants the discount to NAV closed, which is exactly what the other holders should want.

2) Polar’s proposal is not “the answer” and the consequences of their proposal are real, explaining:

“In fact, Polar’s proposal can only be proven to eliminate the discount for the less than 1% of Unit-holders (including Polar) that could utilize Polar’s proposed physical redemption feature. The remaining 99% of Unit-holders are being asked to trust Polar’s opinion while Polar exits its position.”

That, of course, is nonsense.  Again: if I’m a GTU holder, I don’t care that I can’t buy and redeem enough units to get a gold bar: the act of others doing it will drive the price up and close the discount!  Yes, again we have that tax issue addressed above, if the redemptions actually happen – but more on that later….

3) etc etc etc

Amazingly, next, Institutional Shareholder Services, a proxy advisory firm, came out on the side of the Trust, and recommended that unit holders vote against Polar’s proposal! ISS wrote:

“Overall, the short-term and opportunistic nature of the dissident proposal constitutes a cause of concern for  long-term unit-holders. In addition, by just amending the trust’s Declaration of Trust and not providing a detailed business plan with new strategic initiatives on how to better manage the trust, the dissident’s request to replace the majority of the board appears overly demanding”

I was surprised by this, as there’s nothing “short-term” about a redemption feature that would protect all shareholders from future NAV dislocations.

Polar, of course, “disagreed” with the ISS recommendation, noting, among other things:

ISS displays lack of capital markets understanding” – which I completely agree with.

Polar added a few more bullet points, which I agree with:

 

  • ISS ignores peer comparisons, governance failures and needless value destruction
  • CGT discount to NAV could widen further without effective redemption feature
  • Polar has proposed the ONLY solution to eliminate the significant trading discount to NAV

This week, Polar figured they’d try to counter some of the GTU Board of Trustees responses that were off base, so they committed to not redeeming any GTU shares for the remainder of 2015.   Why did they do this?  Because again: they’re not interested in “raiding” GTU’s gold: they’re interested in capturing the NAV discount that should be remedied.   Polar knows that even if they don’t redeem, the discount is highly likely to close if a redemption feature is added.  Either the market will correctly price the units to reflect their NAV, or other arbitrageurs will come in an ensure that the price reflects the proper value – redeeming if necessary.

I’ll give you one guess what happened next:  GTU’s board responded again, in a PR titled “Polar’s Empty Promise To Delay Their Redemption Does Nothing to Correct the Fundamental Flaws in Their Proposal.”  Shockingly, GTU basically seems to be accusing Polar of lying about not redeeming, because GTU, like the ISS, seems to lack an understanding of how capital markets work.  GTU’s Special Committee Chairman added:

“…Such a delay does not level the playing field for the over 99% of Unit-holders who could not utilize their proposed physical redemption option, and who would be inheriting the increased cost and potential tax liability that come with it”

Again, this is ludicrous: GTU holders do not have the ability to redeem their shares at NAV.  Under Polar’s proposal, small shareholders would *still* not have this ability, but they’d be massive beneficiaries of the fact that others do have this ability.  Yes, again we have that tax issue, which is like complaining about pennies when someone is offering you dollars.

I already loved this story, as it was a back and forth between some guys who just wanted to help shareholders (and themselves, of course) realize the underlying value of their investment, but were being fought on all fronts by some shareholders and by the Trust itself.   But wait – today the drama kicked up a notch when none other than Sprott Asset Management jumped into the fray, making an unsolicited offer to exchange shares in GTU and SBT.TO for newly issued shares of its own physical bullion trusts: PHYS and PSLV.   Sprott (I’m using “Sprott” for “Sprott Asset Management” here, not to indicate “Eric Sprott”)  is basically proposing a takeover of the Central Trusts, where shareholders would receive shares of Sprott’s trusts instead, and Sprott would merge the underlying metal into their own trusts.

Brilliant!   I would expect that not a single goldbug site will write about Sprott trying to “raid” the Central Trusts, although that’s exactly what they’d be doing: piling the bullion under the Sprott umbrella so that Sprott Asset Management can get the management fees that Central Trust has been getting.  Never mind the fact that Sprott’s total fees are roughly 20 bps higher than Central Trust’s, or that when units are redeemed from Sprott’s trusts there are tax consequences like the ones Central Trust has been complaining about – if I were a GTU shareholder I’d be psyched for this offer! Well, we don’t know the exact terms of the offer yet – Sprott filed an SEC doc with some details, including that the exchange would be on a “NAV for NAV” basis, but I’d like to see the final details before blessing it.

Basically, though, I very much agree with Sprott’s CEO, John Wilson, who noted:

“It’s really just a very simple solution,” he said in an interview. “Why would you own that unit when you have opportunity to own a more liquid unit that does all the things you want and trades at its intrinsic value?”

Indeed!  I have been critical of Sprott on these blog pages in the past, but this one is a no-brainer for Sprott Asset Management, and probably for Central Trust unit-holders as well (side notable: Eric Sprott is no longer the man in charge – at least not officially – at Sprott Asset Management).   Sprott Asset Management knows – or perhaps GTU’s largest unit-holder, Pekin Singer Strauss, told them –  that while Canadian retail precious metals investors might be distrustful of some evil arbitrage fund trying to raid the metal from their trust, Canadian retail precious metals investors love and *trust* Sprott!  Hence, the beauty of this exchange offer, which, if successful,  would result in PHYS increasing its assets by roughly 50%!  You can do the math yourself, but Sprott Asset Management is looking at more than $ 3MM in additional annual management fees alone.  Synergies!

Of course, Polar already put their 2 cents in, issuing a PR that said that they welcomed the Sprott Exchange Offer– which, well, of course they do! The Sprott exchange offer, if it’s truly on a 100% NAV to NAV basis, will narrow the NAV discount that the Central Trusts are facing.

Nothing on this page should be construed as investment advice, which I couldn’t possibly give since we don’t know the details of the exchange offer anyway, but if I were a GTU shareholder, I’d be ecstatic about the Sprott Exchange offer’s preliminary details.   I can’t wait to see how the GTU board of Trustees reacts to this approach, especially since they’ve already pounded the table on the tax issue, while Sprott’s trusts face similar tax issues.   GTU’s board has also brought up management fees, but Sprott’s funds have significantly higher fees.   In other words, I think that it will be very hard for GTU’s board to deny the significant accretion that their unit-holders are likely to see under the Sprott exchange, but it’s also going to be odd to see them ignore the complaints they brought up multiple times in the back and forth with Polar.

Sprott’s CEO insinuated in a Bloomberg interview that it was GTU’s largest shareholder, Pekin Singer Strauss (probably nervous that Polar’s proposal was meeting resistance from GTU’s exceedingly naive shareholder base) who approached Sprott with this master win-win plan: “through that process some of those unit-holders reached out to us and thought we might offer a better solution” – I can’t wait to see how GTU’s Board reacts to this whole thing…

Stay tuned – this is pure gold for closed end fund geek drama…

-KD

I have no positions in GTU, SBT.TO, PHYS or PSLV