On April 28th, 2006,
Barclays launched the first silver exchange-traded fund in the US. Traded
on the AMEX as SLV, the iShares Silver Trust was
eagerly anticipated by silver investors ahead of its birth. It ushered
in a new era where vast pools of stock-market capital gained an easy conduit
into the physical silver market.
One of the reasons
investors originally liked SLV so much is silver consumers aggressively
lobbied the SEC to kill it. The Silver Users Association wrote some
fascinating letters to the SEC bemoaning the birth of SLV as the end of cheap
silver as we knew it. Established in 1947, the SUA is an organization
of industrial users of silver in applications including photographic, electronic,
silverware, jewelry, and other fabrication.
In a February 13th, 2006
letter to the SEC, the SUA’s director claimed
its members processed “80% of all silver used in the United States”.
In the conclusion of its plea to the SEC to not approve SLV it said,
“The Silver Users Association opposes the creation of a silver ETF because of the concerns that doing so will
require the holding of physical silver in allocated accounts, thus removing
large amounts of silver from the market.”
With SLV generating some
controversy lately among a small subset of contrarian investors, remembering
how aggressively the silver industrial consumers opposed it prior to
its launch is illuminating. The SUA was terrified of stock investors
gaining easy access to silver and driving a huge silver spike. It said
“the proposed silver ETF could be a legal way for investors to squeeze
the silver market.” The SUA knew the silver ETF would take a huge
pile of physical silver bullion off the markets, driving up prices.
Just over two years later,
the SLV silver ETF has been a major success. It has given
non-traditional silver investors in the stock markets an easy way to gain
silver exposure in their usual stock-trading accounts. Stock-market
capital shunted into the silver market via this ETF has pulled a vast amount
of silver off the markets, as the SUA feared. And today with years of
trading history under its belt, there is finally enough data to analyze SLV’s impact.
I’ve been a big fan
of commodities ETFs since 2002, two years before the
launch of the GLD gold ETF and four years
before SLV was born. Despite this, I will probably never invest in
either GLD or SLV, although I will use them as short-term trading vehicles to
speculate. Why? I am a physical guy. When I buy gold and
silver to undergird my own investment portfolio, I
want physical bullion coins held in my own
immediate physical possession. To me, everything else is inferior
paper.
A lot of hardcore
contrarians feel this way, they wouldn’t touch
SLV with a ten-foot pole. And this is fine, as SLV is not designed for
traditional buyers of silver bullion. The target market for SLV is
stock traders who haven’t owned physical silver yet. It is like a
gateway drug for them. I’ve heard from many investors over
the last four years who started out owning a little GLD or SLV and “graduated”
into buying bullion.
SLV is also for
institutional investors like mutual funds that can’t buy physical
silver bullion. Their charters restrict them to trades in the stock
markets. As a physical-bullion owner, I am thrilled when institutions
bid up SLV which ultimately shunts stock capital into silver. SLV is
also for speculators. If you want to trade silver for a multi-month
run, it is impractical and very inefficient to buy or sell physical bullion
to do this.
So if you don’t like
SLV, don’t buy it. I hate Chinese food with a passion (sorry),
but that doesn’t mean I would ever want it off the market. If
others like it, more power to them. I’ll eat my steak, they can
eat their rice. The more avenues for silver investing, the easier it is
to deploy capital in the silver sector, the better off all silver investors
will be regardless of how they choose to hold their silver.
SLV is not designed as a
physical-silver substitute, but as a silver tracking vehicle. It
attempts to mirror the performance of the silver price. There is only
one way this can be done. Any time supply/demand pressures in SLV
threaten to veer away from those in silver itself, SLV has to adjust its own
physical-silver holdings to equalize this pressure differential. If it
doesn’t, SLV will cease tracking silver and fail.
If stock traders bid up SLV
faster than futures traders bid up silver itself, SLV will threaten to
decouple to the upside. Its custodians must shunt this excess demand
into silver to restore balance and maintain tracking. They do this by
issuing more SLV shares. The additional supply of SLV sops up the
excessive demand and raises cash. Then the custodians use these
proceeds to actually buy more physical silver. This process effectively
shunts stock capital directly into the silver market.
The conduit SLV opens for
stock-market capital to flow to silver is a double-edged sword though. If
SLV is being sold faster than silver, SLV will decouple to the
downside. In this situation its custodians must buy back SLV shares to
absorb the excessive supply. Where do they get the cash to do
this? They sell some of their physical silver bullion, equalizing SLV
selling into silver itself. Like GLD for gold, SLV increases both
upside and downside volatility in silver.
This standard ETF
methodology of normalizing supply/demand imbalances between an ETF and the
asset it tracks helps explain this first chart. It shows SLV’s silver-bullion holdings along with the silver
price. When SLV’s holdings grow, SLV ETF
demand exceeds that of silver itself. When SLV’s
holdings contract, SLV supply exceeds that of silver itself. As this
chart shows, so far SLV’s demand growth has
far outstripped silver’s.
When SLV was born in late
April 2006, it had 21m ounces of silver stored in trust. But this
highly-anticipated ETF proved hugely popular and SLV demand growth far
exceeded that of silver itself. So SLV’s
custodians issued more shares and used this cash to buy more silver to
equalize this imbalance. Just two weeks after launch, SLV’s holdings had more than tripled to 65m
ounces!
Unfortunately, silver
itself was topping on May 11th, 2006 after a massive 124% upleg.
Some revisionist analysts today want to attribute that silver crash to SLV’s influence, but this theory is just plain
silly in light of history. In early May 2006 gold itself was overbought
and due to correct, and silver follows gold. In our
April 2006 Zeal Intelligence newsletter, published weeks before SLV
launched and silver topped, I wrote…
“…silver
exploded up in a way that only speculators can drive. While exciting,
such a surge demands extreme caution. Silver has stretched
nearly as far over its key 200dma support now as it did back in April 2004
before a wickedly vicious crash. If you have leveraged silver longs do
not forget that silver tends to fall faster than it rises and such
corrections happen blisteringly fast with virtually zero warning. While
I remain incredibly long-term bullish on silver, the short-term probabilities
overwhelmingly favor a correction now.”
Silver’s May 2006
correction was anticipated well before SLV launched. And SLV’s holdings also show that the thesis it drove
the May 2006 silver crash is pure nonsense. In the two weeks following
its May 2006 top, silver plunged 15.9%. Yet SLV’s
silver-bullion holdings actually grew by 13.7% over this same span of
time. SLV was actually buying silver bullion, retarding the
silver crash, not selling and exacerbating it!
On May 12th, 2006, the day
this crash started, silver fell 4.9%. Yet SLV’s
holdings simultaneously soared by 4.8% in a single day. Silver
crashed because it was technically overbought and greed reigned, SLV had
nothing at all to do with it. Ultimately silver shed 35.1% in May/June 2006 in just over four
weeks. Over this very same span of time, SLV’s
holdings grew by 10.4%. So realize SLV-spawning-silver-crash
theories are total nonsense.
After being stable through
this silver crash, SLV’s popularity resumed
and its silver holdings surged again. This growth was all the more
impressive considering silver was merely grinding sideways in a high
consolidation after that May 2006 crash. Yet SLV demand growth far
outstripped silver demand growth so SLV’s
custodians had to keep buying bullion. By August 2006, four months
after birth, SLV’s holdings had already
nearly quintupled to 100m ounces!
When silver weakened
further in 2007, especially during its usual dull summer months, SLV still
continued growing slightly on balance. This is very impressive.
SLV holders were not scared by the silver weakness in Q3 2007, which implies
they were strong hands with a long-term perspective. Since SLV still
had to slowly add to its holdings, stock-market demand for SLV continued to
exceed that for silver itself.
By late 2007, SLV’s holdings surged again on renewed popularity
sparked by silver’s latest major upleg.
Since SLV had to buy bullion so fast, demand growth for SLV from the stock
guys was once again running at a much higher rate than demand growth in
silver itself from the futures guys. Provocatively, SLV’s
holdings even grew during the latest silver crash in March so SLV buying
actually moderated silver’s downside!
Over four trading days in
March 2008 surrounding the Fed’s “restrained” 75 basis-point
cut that hammered commodities speculators, silver plunged 19.0%. Yet SLV’s silver-bullion holdings, over this same span
of time, grew by 2.0%! Thus SLV sellers were selling slower and
less frantically than silver sellers which created a supply/demand imbalance
that forced SLV’s custodians to buy
silver bullion during this panic.
So in light of its soaring
silver holdings, SLV has been a dazzling success. The Silver Users
Association was right to fear it. Today SLV holds about 195m ounces of silver
bullion on behalf of American stock traders! This is stellar 828%
growth in just over two years. To put this number into perspective, the
top three primary silver miners in the world will only produce 19.5m, 16.0m,
and 15.0m ounces respectively this year.
In 2007, these same three
elite companies produced 41.7m ounces collectively. Thus SLV, merely
two years into its existence, has already taken the equivalent of nearly five
years’ worth of silver production from the three largest primary
silver miners off the market. No wonder silver has gone from trading
around $11 to trading around $17 during SLV’s
life. 195m ounces is a lot of silver
buying!
And I suspect much of this
SLV buying wouldn’t have existed if there wasn’t a silver ETF. Traditional physical-silver buyers who
hate SLV would have kept on buying coins and bullion as always whether or not
an ETF existed. But non-traditional investors, stock traders who wanted
some silver exposure in their portfolios, would almost certainly not have
gone through the trouble of buying that much physical. Some would have,
but the great majority of SLV buying is probably brand-new non-traditional
demand.
In my studies of the
immensely popular GLD gold ETF, which is already the sixth-biggest ETF in the
US,
I always look at trading volume in the ETF itself. SLV’s
trading volume should also offer insights into how its popularity is growing
and how silver-price movements affect the psychology of stock traders owning
SLV. Not surprisingly, the volume trends in SLV are very similar to GLD’s in its own first couple
years.
Visually, SLV trading
volume had a fairly flat trend for most of 2006 and 2007. This could be
interpreted as traders failing to grow more interested in it. I doubt
this though for a variety of reasons. First, silver was grinding
sideways in a high consolidation during that time. Prices drifting
lower tend to repel speculators since excitement ceases to exist. So
SLV maintaining its volume despite a long consolidation is impressive.
Second, with flat share
volume and a silver price rising on balance ($13s in mid-2007 compared to
$10s in mid-2006), capital volume was rising nicely. Capital volume is
the share price multiplied by the number of shares traded. In a
rising-price environment, the capital involved grows even if share volume
trends sideways. More capital was getting interested in SLV all the
time, as its silver holdings certainly reflected.
Finally, the solid red line
labeled “Gradually Ramping Up” is
actually a mathematical best-fit line. So SLV volume was growing
over this entire span statistically. Provocatively SLV volume utterly
soared earlier this year as silver surged from $17 to $21. This is
great news too, as it means more stock traders are watching the silver market
and flooding into SLV when silver starts getting interesting. Capital
volume was huge.
Just like GLD, SLV’s biggest volume spikes generally occurred
during selloffs. This is pretty typical in
all financial markets. While the greed driving buyers to bid up a price
gradually builds over months, fear can flare up intensely in a matter of hours.
Fear and greed are very asymmetrical in their urgency, making sharp
fear-driven plunges much more probable than sharp greed-driven rallies.
But despite these big SLV
volume spikes reflecting heavy selling on silver’s declines, it is not
disproportionate to the supply/demand pressures in silver itself. Since
SLV’s holdings rarely ever decline by much,
it is not being forced to liquidate much, if any, bullion during these
selling episodes. This means SLV selling pressure is staying pretty
proportional to actual silver selling pressure when the metal swoons. I’m
glad to see this because SLV would really amplify silver’s downside if
SLV traders got too frightened.
This final chart examines SLV’s success in achieving its core mission,
tracking the silver price. The yellow line is the SLV share price
divided by 10 (since each SLV share represents 10 ounces of
silver). It is superimposed over the actual silver price which is
rendered in blue. The red and white lines represent the 5-day moving
averages of variances between spot silver and the SLV and the London silver fix and
the SLV. The latter is included because SLV’s
custodians use London
silver as their tracking benchmark.
SLV’s custodians
should be commended, because they have done an outstanding job of keeping SLV
tracking silver. Since its birth SLV and silver have had a stellar
daily correlation r-square of 99.9%! This means that for tracking
purposes SLV effectively is silver. Considering how
hyper-volatile silver tends to be in history, this achievement is really
impressive. I can’t imagine a harder commodity to tightly track.
Now if you follow the
yellow SLV/10 line, early on it totally obscures the blue silver line. Its
tracking was incredibly tight. But lately, more blue is showing which
means SLV’s tracking is loosening a
bit. This development is also reflected in the downtrend of the red silver/SLV
variance line. While slightly looser tracking may concern some, it is
totally normal and expected over the life of any ETF.
Like everyone else
providing a valuable service, the ETF custodians deserve to earn a
living. It is hard work launching and managing an ETF to keep it
tracking its underlying commodity. To provide this service, they charge
SLV owners 0.5% of this ETF’s assets
annually. They sell a little silver each year to pay expenses and earn
a reasonable profit. So after the first year, SLV is only 99.5% backed
by silver, after the second 99.0%, etc. All ETFs,
including the pure stock ones, work this same way.
So a decade after it went
live, SLV will only be 95% silver-backed. Understandably this bothers
some people, and if you are one of them SLV is not for you. This is one
minor reason why I only use physical silver bullion, under my own immediate
physical control, for my own personal long-term silver
investments. But regardless, ETFs cost money
to run so taking a small cut out of assets annually is the only way they can
exist. Think of it as a convenience fee.
For speculators, this is a
stellar deal. Rather than paying huge commissions on physical silver,
and dealing with the hassles of physical trading, they can buy SLV for
trivial stock commissions. If they are gaming silver moves running less
than a year or so, the custodians’ cut is immaterial anyway. Yet
they can effectively trade silver, in a stock account no less, for stock
commissions. And just as options on GLD were just introduced this
month, sooner or later stock options on SLV will hit the market too. SLV
is a speculator’s dream.
Anyway, the red variance
downtrend above reflects SLV’s expense
ratio. It will keep dropping, by about 0.5% a year, until SLV is wound
up and retired at some undefined point in the future. Since secular
commodities bulls tend to run for about 17 years historically, eventually
silver will get too overbought like in January 1980 and enter a multi-decade
secular bear. So there is no need to hold SLV forever, just until the
end of today’s bull. After that it will be retired I’m
sure.
So just after its second
birthday, SLV has far exceeded my own expectations. It has indirectly
put a vast quantity of silver in non-traditional silver investors’
hands, expanding both the silver market and general interest in silver.
It has fulfilled its mission of tracking silver closely, granting cheap and
easy silver exposure to all stock traders. Like GLD, it is a huge
success story for investors and precious metals.
If you are a hardcore
physical-silver guy, and you hate SLV, then
don’t buy it. If you’d rather own coins or bars, buy
them. If you’d rather own silver stocks, buy them. But
realize just because you prefer one way to invest doesn’t mean
alternative ways shouldn’t exist. The more capital that floods
into silver, regardless of where it comes from or how it enters the market,
the higher the silver price will ultimately go for all of us. We want
other investors to follow us in! SLV is a gateway drug leading to more
serious silver investment.
And if you are a stock
trader, and you want to buy some SLV to add silver exposure to your
portfolio, go for it! Ignore the fearmongers.
Like every other publically-traded entity, SLV has
all kinds of regulations and reporting requirements so there is no reason to
believe it is not storing physical silver bullion as it says it is unless proven
otherwise. Paranoia surrounding alternative investment vehicles always exists, I have had to deal with it constantly for the six
years I’ve been writing about commodities ETFs.
At Zeal, we like all forms
of silver investing and speculating. We first started recommending
physical silver bullion to our newsletter subscribers in November 2001 when
it traded at $4.20. We have traded in and out of countless silver
stocks over the years for excellent realized profits. And we are
eagerly looking forward to silver’s next big upleg
which will probably start with gold’s after we sail through the usual lackluster summer doldrums.
We just published an
awesome new report detailing the fundamentals underlying our favorite silver stocks. We started researching
nearly 80 silver stocks and gradually whittled this field down to our favorite 12. Buy our report today and learn about the high-potential
silver stocks we are looking to buy early in silver’s next upleg. We also publish an acclaimed monthly newsletter that analyzes
the markets and trades commodities stocks accordingly. Subscribe now!
The bottom line is SLV has
been a great boon for all silver investors. It has created a conduit
for stock-market capital to chase silver directly. Through this
vehicle, non-traditional silver investors who probably would never have or
could never have bought coins or bullion now own hundreds of millions of
ounces of physical silver held in trust. On top of this SLV has tracked
silver beautifully, realizing its core mission.
While SLV
isn’t for everyone, particularly hardcore traditional physical guys, it
is really expanding the silver fold. Mainstream investors who are new
to precious metals can buy a little SLV, which not only adds silver-price
exposure but gets them watching silver regularly. SLV helps spread the
silver gospel. And the more investors and capital that grow interested
in silver, the bigger its secular bull will ultimately be.
Adam
Hamilton,
CPA
Zealllc.com
June
20, 2008
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comments, or flames? Fire away at
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