A Sprott Fund That’s Not

January 30, 2012

Putting platinum and palladium into one fund makes no more sense than if you combined gold and silver. Actually, it makes less. In the last decade, the correlation between the price of gold and silver has been 95 percent, compared to 76 percent between platinum and palladium.


Gold vs. Silver Decade Correlation


Platinum & palladium decade correlation


This could partially be explained by the fact that platinum is much more of a “discretionary” metal than palladium. According to the World Gold Council, the demand for platinum as an investment and for jewelry is five times higher than it is for palladium. By contrast, gold demand is only 2.5 times greater than silver for discretionary spending.

In the future, this trend is likely to continue as more efficient technology is developed to replace the use of platinum in autocatalysts by the cheaper metal—palladium.

You Don’t Get What You Pay For

Most often, the reasoning for buying into a physically backed precious metal closed-end mutual fund—as opposed to futures-based funds, commodity ETNs or equity ETFs—is that ownership in such a fund, like Sprott’s, represents a claim on a segregated, verifiable amount of physical assets.

In other words, investors can redeem their shares in bullion, instead of cash. Fair enough, but how much of each would investors own in a two-metal fund?

Well, it turns out that investors would get somewhere around twice as much palladium in the Sprott’s physical platinum and palladium fund, according to a passage on page 16 of the prospectus:

“The Manager intends to purchase approximately equal dollar amounts of each of physical platinum and palladium bullion in an aggregate amount approximately equal to net proceeds of the offering less the amount to be held by the Trust to pay ongoing expense.”

In laymen’s terms, shareholders will be left with owning more bullion of whatever is cheapest at the time of purchase. Because platinum averaged $1702.6 per troy ounce over the past year versus $724.6 for palladium, a bit of back-of-the-envelope math yields the conclusion that investors will own more than twice as much palladium as they would platinum.

Furthermore, on the same page, the prospectus says that the amount of physical platinum and palladium bullion a redeeming shareholder is entitled to receive may not be “in proportion to the value of the physical platinum and palladium bullion held by the Trust.”

Simply put, combining two metals in one fund with no guarantee on the type of bullion redemption is a gamble.

Investors may be better off getting exposure to both metals with two separate investments. At least then they aren’t left with crapshoot exposure and a grab bag at the time of redemption.

Perhaps the root of my rant has to do with the fact that physically backed metals in a closed-end fund wrapper exist in a no man’s land. Often, they are difficult for investors to enter and exit at low cost.

If investors want quick precious metals exposure, why not settle for open-end funds, such as the ETFS Physical Platinum Shares (NYSEArca: PPLT) and the ETFS Physical Palladium Shares (NYSEArca: PALL)? PPLT and PALL are real ETFs, as I defined them above, meaning their prices and net asset values are by design meant to converge.

At the end of the day, in any physically backed fund—closed end or ETF—managers chip away at bullion to pay off redemptions and other expenses.

So, for investors who really want to own the physical metal, why not buy bullion directly? The amount you’d own would stay the same—plain and simple.

Yes, storing bullion may be tricky, but it also guarantees complete control over the investment, which is more than you can say for what Sprott is offering.


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