The Sovereign Society Offshore A-Letter

New Canadian Gold Fund Offers a Twist

By Eric Roseman

A unique new closed-end gold fund hit the Canadian market last Friday, with more than $366 million (C$400 million) from institutions and investors.

Although introduced as a closed-end fund, if in six months the fund trades below its NAV, it will automatically convert into an ETF. The much-anticipated offering also offers more unique twists compared to other globally-traded gold fund for two important reasons.

The Claymore Gold Bullion Trust (Toronto-CGL.UN) is the first Canadian dollar denominated gold fund to hedge its U.S. dollar exposure back into Canadian dollars. That’s a major shift away from other gold ETFs and closed-end funds in Canada, which don’t hedge out the U.S. dollars’ exposure.

Since gold prices are quoted in U.S. dollars, investors in Canada have assumed adverse currency consequences since 2003 when the loonie began its ascent north of 1.60 versus the American dollar. The loonie opened this morning at 1.09.

Basically, Canadian investors (and foreigners) wary of holding U.S. dollar denominated gold funds can now maintain their constant purchasing power in local currency while participating in the gold bull market.

Over the last four weeks, for example, the loonie has surged 8% vis-à-vis the American dollar while gold prices have gained about 10%. A hedged gold bullion portfolio in Canadian dollars would have captured most of that total return; but in the absence of this hedge Canadian investors have barely benefited from gold’s recent upturn. The same goes for EUR, Norwegian kroner, Brazilian real and a host of other foreign currencies – all robbed by gold’s decline in dollar terms.

The second unique feature about Claymore’s new gold fund is the tax treatment of capital gains.

U.S. institutions were heavily involved in Friday’s offering because the deal offered a tax arbitrage strategy for gold bulls. Investing in the Claymore structure attracted a lower rate of tax than if the same investor made a similar investment in a U.S. product. If a U.S. investor holds physical gold in an ETF the capital gains attract a luxury tax at 28%; but holding the same investment in an offshore corporation or a trust – the structure that applies for U.S. institutions buying the Claymore Gold Bullion Fund -- attracts a lower 15% tax rate.

For U.S. investors the Claymore Gold Bullion Fund serves as an ideal investment tool to hedge against the long-term decline of the U.S. dollar. And unlike a regular gold ETF based in American dollars this one offers the chance to profit from currency appreciation and rising gold prices.

As for timing, now is not the ideal moment to place this trade. Commodity currencies have skyrocketed since last month and gold along with other commodities have surged as the American dollar has tanked.

Commodities and most foreign currencies are severely overbought. The Canadian dollar, which raced above par value against the U.S. dollar earlier in 2008, posted its biggest monthly gain in more than 16 years in May. Don’t chase prices. A correction lies ahead this summer.