Launched 4 years
ago this week, the SLV silver ETF has
proven very successful. With $5.1b in net assets, it already ranks
among the top 20 largest ETFs in the US.
And the 287m ounces of physical silver bullion it holds in trust for its
stock investors is impressive. For comparison, elite market-darling
silver streamer Silver Wheaton only produced 17m ounces last year (equivalent
to 6% of SLV’s holdings).
SLV has truly
become a force to be reckoned with in the silver world, fulfilling the worst
fears of silver’s industrial users who actively lobbied the
SEC against approving this ETF before it was born. They feared
the massive pools of stock-market capital that would flood into physical
silver via this new ETF conduit would drive up prices. They were right,
silver was trading around $12 when SLV came online.
But SLV has
proven a boon for silver investors on multiple fronts. Most
importantly, more capital chasing the small silver market ultimately means a
longer secular bull powering to a higher climax. SLV created a
first-ever conduit for stock investors, which aren’t traditionally
physical-silver investors, to easily migrate capital into silver.
Billions of dollars of stock-market capital have already flooded into this
metal that probably wouldn’t have otherwise.
SLV also offers a
crucial glimpse into silver-investor psychology that we have never had
before. Its custodians are completely transparent, publishing its
physical-silver-bullion holdings on a daily basis. Watching these
holdings change over time, especially when considered alongside silver price
action, offers countless insights into how stock investors are feeling
about silver at any given time.
This is due to
the innate mechanics all ETFs share. Any ETF intending to track an
underlying asset must actively shunt capital to and from the actual
underlying asset to equalize supply-and-demand differentials between the
ETF itself and the underlying asset. In SLV’s case, its share
price is determined by the real-time supply and demand of its shares.
If stock investors as a whole are buying more SLV than they’re selling,
its price rises. If they are selling more than they’re buying,
its price falls.
But SLV is
explicitly designed to track the silver price, to give stock investors the
functional equivalent of silver exposure in their portfolios. And
silver has its own unique supply-and-demand profile totally independent of
SLV’s. At any given moment if there is more silver demanded than
supplied, its price will rise. And if there is more silver offered than
wanted, its price will fall. The only way to synchronize the
independent supply-and-demand profiles of SLV and silver is through active
ETF management.
SLV’s
custodians equalize these different profiles by shunting any differential ETF
supply or demand directly into physical silver bullion itself. This is
the only way tracking ETFs can function, and SLV’s efficiency in tracking silver is
perfect. When SLV demand is running higher than silver demand, SLV
shares threaten to decouple to the upside. To prevent this, SLV’s
custodians issue new SLV shares to meet the marginal demand and use the cash
raised to buy more physical silver bullion.
Conversely when
SLV supply is greater than silver supply, SLV shares will decouple to the
downside. Of course any decoupling will destroy this ETF’s
tracking and scuttle its mission. To prevent this scenario, SLV’s
custodians buy back this ETF’s shares to sop up the excess
supply. They get the cash to do this by selling some of the physical
silver bullion they are holding in trust for stock investors. The net
impact is excess stock-market demand or supply is shunted directly into physical
silver itself.
This mechanism
means changing SLV holdings effectively reflect stock investors’ views
on silver at any given time. If SLV’s holdings are rising, it
means stock investors are buying SLV shares at a faster rate than silver is
being bought. They are not only bullish on silver, but actively buying
more exposure to it via SLV. And when SLV’s holdings are falling,
there is less demand for silver exposure among stock investors than for
silver itself. They are relatively bearish, either selling faster than
silver is being sold or buying slower than silver is being bought.
And of course
understanding stock-investor psychology on silver offers excellent insights
into where silver is likely heading in the near-term. When stock
investors get too bullish on silver, driving SLV’s holdings up too fast,
it probably means an interim top is near in silver. And when they get
too bearish, forcing SLV to liquidate silver too rapidly, it probably
portends an imminent interim bottom. Thus it is important for silver
traders to monitor SLV’s holdings on an ongoing basis as a key
sentiment indicator.
All this brings
me to the topic of this essay. A strange divergence has developed in
SLV’s holdings since early March. Over a span of time where
silver has rallied nicely, SLV’s holdings have plunged rather sharply.
I’ve been watching this with increasing interest. It is readily
apparent in this chart, where SLV’s holdings are plotted in red along
with the silver price in blue. This divergence is the largest ever.
On March 1st,
SLV’s holdings ran nearly 305m ounces of physical silver bullion.
At the time, silver was trading around $16.50 and had rallied nicely (9.6%) since
its interim low a few weeks earlier in February. But despite silver
continuing to rally on balance, SLV’s holdings started falling rather
sharply. Almost 7 weeks later, SLV had shed 6.0% of its silver over a
span where silver actually rallied 7.7%.
This is quite
literally unprecedented. Prior to this past month, SLV’s largest
decline in holdings over the same span of time was merely 3.5%. And
that was near the heart of the stock panic in December 2008, an
exceedingly-rare event that wreaked unbelievable havoc on
the silver price. Today’s psychological environment is obviously
vastly different from the one driven by plunging silver during the
panic. At one point this metal’s price had plummeted 33% in just
4 weeks!
Put in quantity
terms, SLV has shed over 18m ounces of silver since early March.
This physical silver bullion has hit the marketplace, retarding the advance
of silver’s new upleg. This is a staggering amount of silver to
hit in a short period of time, more than the 17m ounces elite market-darling
Silver Wheaton produced in all of last year. I’ve really been
trying to understand the psychology behind this odd divergence.
Silver, and its
primary driver gold, have both done well since their latest corrections
bottomed and bounced in early February. At best since then, silver and
gold have rallied 22.9% and 9.3% respectively. These are sizable
rallies over a relatively short 10-week timespan. And silver has even
easily outperformed the flagship S&P 500, which rallied 14.7% since its
own interim low of early February.
With gold and
especially silver looking strong heading into their usual spring rallies,
you’d think stock investors would be getting more bullish on
silver. Nothing grows interest in an asset faster than relentlessly
rising prices. Yet as is clear from the sharp reduction in SLV’s
bullion holdings, SLV demand from stock investors has waned
considerably. They aren’t the least-bit excited about this new
silver upleg yet.
One possibility
is that stock investors are actually selling SLV, reducing their silver
exposure. It is hard to rationalize the psychology behind this
possibility though, especially given silver’s strong performance lately
and its current high levels relative to most of today’s bull. A
second possibility is stock investors are just buying SLV at a slower rate
than silver itself is being bought. In order to prevent SLV from
falling behind silver and decoupling, its custodians have sold bullion and
used the cash to buy back shares.
While we
can’t know for sure what is going on in the hearts and minds of all SLV
investors, this second possibility seems far more likely. As I
discussed last week in a Silver/Gold Ratio analysis, gold
is the primary driver of silver psychology. Silver traders endlessly
watch it for trading cues. And though gold has rallied respectably
since early February, its rally hasn’t been exciting. There have
been few fast surges and no new highs, gold has kind of been melting up
slowly much like the general stock markets.
And without
fast-moving gold to spark some excitement in silver, the stock traders
haven’t had much incentive to add to their SLV holdings. The net
result is SLV exposure has been drifting and lagging silver’s advance,
necessitating this ETF’s bullion selling to buy shares to maintain
tight silver tracking. As soon as gold’s upleg accelerates and
gets silver traders excited, SLV’s waning holdings should reverse.
But at the
moment, SLV’s custodians have had to dump over 18m ounces of silver
onto the markets in less than 7 weeks. Roughly equivalent to the
annual production of some of the world’s biggest and best primary
silver producers, this had to weigh on silver’s young upleg. If
relatively-low SLV demand hadn’t forced this ETF to dump so much
physical silver, I suspect silver’s gains since early March would have
been considerably larger.
This SLV
divergence also highlights the double-edged nature of precious-metals
ETFs. When demand for their shares is high so they have to expand their
metals holdings, they are very bullish for prices. But when stock
investors start selling or not buying as fast as the underlying metals are
rising, the ETFs must contract their holdings to buy back shares and maintain
tracking. These ETFs add capital, along with its intrinsic volatility
and risks, to the gold and silver markets. This can amplify or retard
underlying moves.
Speaking of gold,
the mighty parallel GLD gold ETF
(third largest ETF on the planet) has not mirrored SLV’s recent
behavior. This makes SLV’s divergence all the more curious. While
SLV achieved its all-time record high of silver bullion held in trust back in
early December (almost 306m ounces), GLD edged up to a new all-time record
high of its own less than 2 weeks ago. And it has held this record,
keeping its holdings steady, right as SLV has been forced to continue to sell
down its own.
GLD’s
enormous holdings have essentially remained stable since major hedge-fund
buying drove them up fast to new records in the first quarter of 2009.
That record surge was extremely important as it proved the fringe conspiracy theorists
claiming these ETFs don’t really buy and sell physical bullion are dead
wrong. As usual, hard evidence fails to support these highly-emotional
flights of fancy that mislead countless investors.
A single large
hedge fund aggressively buying GLD drove its holdings 30% higher in just 5
weeks in early 2009! GLD had to buy 238 metric tons of gold over this
short span which catapulted gold prices almost 23% higher. If GLD
wasn’t shunting differential buying pressure directly into physical
gold bullion, this would have been impossible. There are other
episodes where GLD and SLV bullion buying and selling have clearly and
directly impacted the gold and silver prices. These ETFs truly are
buying and selling physical bullion as advertised.
But I
digress. For our purposes today, GLD has definitely not experienced the
same waning demand among stock investors that SLV has. This makes
SLV’s divergence look even more anomalous. For whatever reasons,
stock investors’ enthusiasm for silver exposure via SLV has been
ebbing. The resulting fast bullion liquidation by SLV to maintain
tracking definitely affects all silver investors.
While
silver’s run since its latest interim low in early February has been
nice, it has had to weather a huge 18m-ounce headwind. There is no
doubt that silver prices would be considerably higher today if SLV
hadn’t been forced to sell so much silver so fast. So if you are
disappointed with silver’s recent run, realize that stock investors are
not only not supporting it but effectively retarding it. This
could reverse anytime though, as a fast gold surge would probably ramp up
general silver enthusiasm quickly.
And while this
magnitude of SLV selling is odd, it does play into a long-known tendency of silver.
In any given upleg, the majority of silver’s gains tend to accrue very
rapidly near its climax. Silver will gradually grind higher early on,
but once it rallies far enough to reach a critical mass of bullish sentiment
then buying floods in and it rockets higher in
short order. It is not uncommon to see around half of the total
gains of an entire silver upleg (which might last 6 months) suddenly flare up
in its final few weeks!
Thus this
apathetic sentiment flowing into silver via SLV from the stock markets could
turn around on a dime. As gold’s young new upleg accelerates,
silver will almost certainly catch a bid and surge sooner or later
here. And when the stock investors see that, I suspect they will once
again be quick to collectively add more SLV exposure. It was psychology
that created this SLV divergence, and psychology that will eventually reverse
it.
At Zeal, we have
been actively investing and speculating in silver and silver stocks since
this metal traded near $4 in late 2001. Our subscribers have earned
fortunes riding this secular silver bull in elite silver stocks. And
whether you love or loathe SLV, there is no arguing that it has grown into a
major force in the silver market. So all silver investors must watch
its fluctuating holdings and integrate them into their silver analyses.
Unfortunately many silver advisors choose to ignore SLV, hobbling
their effectiveness.
Our research is
widely-respected because we take a broader approach, integrating anything
that materially affects supply and demand. We also carefully consider
cross-market impacts, which are increasingly important in this Information
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We expect this current silver upleg to accelerate and
have plenty of high-potential silver-stock trades recommended. It
isn’t too late to buy.
The bottom line
is the SLV silver ETF has grown so large that it is increasingly affecting
silver prices. And lately waning stock-investor interest in silver
exposure has forced this behemoth to dump a great deal of physical silver
bullion into the marketplace. This marginal supply has certainly
retarded silver’s young upleg, not to mention revealed the silver
apathy bordering on bearishness plaguing stock investors.
Nevertheless,
this SLV divergence is unlikely to persist. As gold’s new upleg
continues higher, it will spark renewed enthusiasm for silver as usual.
Existing SLV investors, with their $5b deployed in silver through this ETF,
will certainly take notice and start buying again. And the vast pools
of stock-market capital will once again shift back to flowing into silver
through SLV, expanding silver’s secular bull.
Adam Hamilton,
CPA
Zealllc.com
April 23, 2010
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