Silver’s massive autumn rally has utterly
captivated speculators and investors, their appetite
for all things silver is insatiable.
Interestingly a major driver of this metal’s recent surge was
stock-market buying of the flagship silver ETF, SLV. The larger and more popular this fund
grows, the greater its ongoing impact on silver prices.
SLV was born in late April 2006, so it is relatively
young as far as exchange-traded funds go. Though its birth was shrouded in controversy,
SLV has rapidly grown into a smashing success. Now holding $10.2b worth of physical
silver bullion in trust for its shareholders, it is already one of the
world’s largest ETFs. And
as more stock investors get interested in silver exposure, SLV will only
continue to grow.
Prior to its launch, the industrial silver consumers
lobbied hard to try and convince the SEC to deny approval for this new
physical-silver ETF. The Silver
Users Association, whose members process 80% of all
the silver used in the US, wrote a letter to the SEC in February 2006. It warned the SUA “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.”
And indeed the industrial silver consumers’
fears have come to pass. In
mid-December 2010, SLV’s holdings hit an all-time high of 352.5m ounces
of silver bullion! To put this
into perspective, global silver production in 2009 ran about 700m
ounces. American stock investors,
by buying shares in SLV, have already absorbed the equivalent of half a year’s worth of all the
silver mined in the world.
Provocatively about 1/6th of SLV’s total
silver hoard was acquired in less than 5 months between late-July and
mid-December 2010. SLV’s
holdings shot up 18.9% during silver’s massive 76.0% autumn rally we
saw last year. This is no mean
feat! The 55.8m ounces of silver
this ETF had to buy over this short span is
staggering.
One of the largest primary silver miners in the
world, Pan American Silver, expected to produce around 24m ounces in
2010. US stock investors, through
the mechanism of SLV, snatched up 2.3x PAAS’s entire 2010 production in
less than 5 months! This young
ETF has already grown into a silver juggernaut, an irresistible force that
every silver speculator and investor must keep a close eye on.
Though physical ETFs have been around since the
enormous GLD gold ETF’s
debut in November 2004, unfortunately many investors still don’t
understand how they work. The
mission of an ETF is to track the price
of its underlying asset, to mirror the underlying’s
performance. Since real-time
supply and demand determines all prices, this tracking mission can only be
accomplished in one way. A
physical ETF has to act as a direct
conduit to move capital between investors and the underlying asset.
In SLV’s case, this silver ETF and silver
itself have their own independent
supply-and-demand profiles. If
you decide to buy 100 ounces of physical silver coins today, it doesn’t
affect SLV. And if an SLV
shareholder sells 100 shares, it doesn’t directly affect physical
silver. So if capital
wasn’t flowing back and forth between this ETF and the physical world,
SLV would quickly decouple from silver prices and fail its tracking mission.
Physical ETFs like SLV succeed because they equalize
their own supply and demand into their underlying assets on a daily
basis. SLV actually has to buy
and sell physical silver, otherwise it could not track
silver prices. And since its
launch, SLV has tracked silver prices perfectly less its 0.5% annual expense
ratio. For providing this valuable
service, every year SLV’s custodians take a half percent of the
fund’s assets to pay their expenses (including storing the silver
bullion) and earn a reasonable profit.
SLV has to buy silver bullion when stock investors
are buying its shares at a faster rate than silver itself is being
bought. This differential buying pressure on SLV, if not shunted directly into
silver itself, would quickly lead to SLV decoupling to the upside (rising
faster than silver) and failing its mission. So in these situations, SLV issues new
shares (in huge 50k baskets).
This mechanism is critical for tracking.
Issuing new shares first adds SLV supply to the
market to absorb the excess demand, which keeps SLV shares from rising faster
than silver. SLV’s
custodians then take the proceeds, the cash earned
from selling these new shares, and plow it directly into silver bullion. This equalizes the excess stock-market
demand for SLV shares into underlying silver itself. This silver buying drives up silver
prices to keep them in line with SLV demand. Thus SLV shunts stock-market capital
directly into physical silver.
But opening a large conduit between the vast pools
of stock-market capital and the relatively-tiny silver market is a
double-edged sword. When stock
investors sell SLV shares at a faster rate than silver is being sold, this
differential selling pressure will force SLV to decouple to the
downside. In order to prevent
this ETF from falling faster than silver and failing its tracking mission,
SLV’s custodians have to buy back shares to absorb this excess supply.
Where do they get the cash? From selling some of their silver
bullion. Again in huge blocks of
50k shares (each share represents one ounce of silver), SLV’s custodians
sell however much silver is necessary to fund the buying back of enough
shares to absorb the excess SLV share supply. This equalizes excess stock-market
supply of SLV shares into silver.
This ETF’s silver selling also drives down silver prices to keep
them in line with SLV supply. So
SLV can also shunt stock-market capital directly out of silver.
Without this conduit, a link for capital to flow
back and forth from stock investors and the underlying asset, a tracking ETF can’t work. So watching the flowing and ebbing of
SLV’s holdings offers fantastic insights into how stock investors view silver. When they put differential buying
pressure on SLV forcing it to buy silver, more capital is flowing into the
global silver markets. When they
sell SLV fast forcing it to liquidate silver, capital is flowing out. Thankfully SLV is super-transparent,
publishing its holdings data daily.
Don’t underestimate how radical so much
disclosure is in the precious-metals markets! One of the main reasons conspiracy
theories thrive in the PM world is because actual data is so hard to come by. In the case of gold and silver,
fundamental data like supply and demand is heavily fragmented and often only
available quarterly (and even then
it is only estimates). So
SLV’s daily holdings offer an
unprecedented high-resolution read on a critical aspect of global silver
supply and demand, how American stock investors feel about it.
And as this chart shows, since SLV’s humble
beginnings stock investors have grown increasingly fond of the white
metal. As of its recent record
high in mid-December, SLV’s holdings had multiplied by 16.8x over the short life of this ETF! With such a mammoth footprint today,
no silver speculator or investor can afford to ignore this behemoth’s
activities. SLV’s
silver-price impact is already large and still growing.
As you digest the massive growth in SLV’s
holdings, remember that this ETF’s custodians only buy silver bullion
when demand for SLV shares exceeds
silver demand. And more or less
continuously since April 2006, stock investors have been pouring ever-more
capital into silver.
Silver’s bull run over the past 5 years wouldn’t be
anywhere near as big if stock investors
hadn’t purchased 350m ounces of this metal.
SLV was very popular right out of the gates, even though silver entered a sharp 35.1% correction
just 2 weeks after this ETF was born.
During the 5-week lifespan of that brutal silver correction,
SLV’s holdings still managed to grow by 10.4%! This amazed me then, and still amazes
me now.
Prior to SLV’s launch, traditional silver-coin
investors thought stock investors would be far more flighty and excitable
than the existing silver crowd.
The stock guys would be quick to sell SLV during silver selloffs, amplifying
this metal’s already-sharp retreats. But that hasn’t been the case, amazingly SLV’s shareholders have actually
proven some of the strongest hands in the silver markets! They rarely apply differential selling
pressure, which has really made SLV’s holdings “sticky”
during silver weakness.
During most of 2007 as silver drifted lower, more
stock investors flocked to SLV driving its holdings higher. Incredibly, SLV’s holdings actually grew through 2008’s
epic stock panic. I would never
have predicted this. Between
silver’s July 2008 high and its panic low in November (on the very same
day the stock markets bottomed), this metal plummeted 53.4%. It was a bloodbath! Yet SLV’s holdings somehow grew
by 11.4% over this span, stock investors weren’t selling it as fast as
silver was sold.
Even in the scariest dark heart of that
once-in-a-century fear maelstrom, SLV shareholders stood strong. While silver plunged 33.8% in just 9
weeks leading into the panic’s low, SLV’s holdings only edged
down 0.6% over this span. The
stickiness of SLV’s holdings (which means stock-market investors’
resolve) through that epic anomaly was incredible. As a group, SLV shareholders could
teach traditional silver investors a thing or two about staying calm and
believing in silver’s secular bull even through selloffs!
The biggest risk SLV poses for the silver market is
the vast additional supply it could
add if stock investors start dumping it faster than silver. This would greatly amplify any selloff in already-volatile silver. While I know we’ll see such a
monumental SLV selling event when silver’s secular bull ends, just
after its popular mania climaxes in a vertical parabola, it is probably years
away. This silver bull’s
primary driver is gold,
and the yellow metal’s own supply-and-demand fundamentals
suggest its bull remains young.
I highlight the behavior of stock investors as
illustrated through SLV’s holdings during
the stock panic to fight a popular Wall Street argument against
silver. Silver bears like to make
the case that a big differential SLV selloff is going to crush silver. And if one did happen, it would
indeed. But the sheer stickiness of SLV’s holdings
over the last 5 years, especially through the stock panic, argue
against this thesis. If the
biggest fear event in the global markets since 1907 didn’t ignite an
SLV panic, then what will?
SLV’s holdings surged again during the
post-panic recovery in early 2009, hitting many new records. Interestingly this particular SLV
surge was driven by a parallel surge in GLD’s holdings. A couple giant hedge funds
aggressively bought a massive amount of the GLD gold ETF in early 2009. Many investors followed these elite hedgies into GLD and SLV, rightly betting that their
underlying metals would rise sharply from their irrational panic lows.
Between late 2009 and mid-2010, SLV’s holdings
were largely flat despite the fact silver merely consolidated sideways. We did see some periodic selling when
silver was drifting listlessly or retreating, but these SLV selloffs were
minor. And finally stock-investor
demand for more silver exposure exploded again last autumn as silver started
rocketing higher. Without the
55.8m ounces of silver their differential buying pressure forced SLV to add
since late July, silver’s recent rally would have been much smaller.
SLV’s trading volume is also interesting,
offering insights into when stock
investors push the most capital through in equivalent silver volume. Since each SLV share equals one ounce
of silver (less this ETF’s necessary administrative fees), it is easy
to quantify when stock investors get the most excited about this metal. As I examined some of SLV’s
major volume spikes over the years, the answer was obvious.
SLV’s biggest volume spikes, with rare
exception, happened on silver selloffs. The red numbers above show what silver
prices happened to be doing on days when SLV saw the most shares changing
hands. The blue numbers show how
much the equivalent silver traded was worth. It is great to see how much
SLV’s capital volume has
grown over the years, stock investors are gradually
trading more silver.
Back on one of 2006’s largest volume days, a
brutal 10.8% single-day plunge in silver, 20.7m shares (effectively 20.7m
ounces of silver) traded. But at
silver’s closing price of $9.84 that day, they were only worth
$204m. By March 2008 in another
big silver correction, on a day when silver plunged 9.0%, 31.7m SLV shares
worth $568m changed hands. SLV volume
was gradually ramping up as more stock investors grew interested in silver.
SLV’s volume peaked recently on November 9th,
2010 at a staggering 149.1m shares worth $3998m! That was the day the CME Group raised
margins on COMEX silver futures by 30%, which sparked incredible silver
volatility and unease. Though
silver only closed down 3.2% that day, intraday it plunged 8.3% in just 3
hours. It was amazing to see an
extreme volume day for SLV soar nearly 20x in
capital terms over less than 5 years.
The yellow line above is the quarterly average of
SLV volume, and it was largely flat during 2006 and 2007 despite SLV’s
holdings relentlessly rising. It
started growing gradually in 2008,
2009, and early 2010. And then this
average rocketed up to 28.0m SLV shares per day during last quarter (Q4
2010)! Interestingly, this is not
totally due to that early-November superspike. If you take that 149.1m-share day and
the next day (79.9m) out of the average, Q4 still ran 25.2m shares which dwarfs any previous quarter.
Silver’s huge rally last autumn worked wonders
for stock-investor interest, it evangelized the
potential of silver investing like nothing else could. And given the stickiness of
SLV’s holdings over the past 5 years or so, probabilities are very high
that these new stock investors will stick around. It is great to have them, as the more
capital that flows into silver from any
source the higher its secular bull will ultimately power.
With the biggest SLV volume spikes usually on big
silver down days, you may wonder how SLV’s holdings can remain so
sticky. SLV shareholders are
obviously scared during big silver selloffs since they push through
disproportionately-high numbers of shares. The key is differential. SLV
only has to dump bullion to buy back shares when stock investors are selling
them at a faster rate than silver
itself is being sold. As long as
SLV and silver are moving at the same pace, no bullion has to be sold or
bought.
So far, SLV investors haven’t sold their
shares faster than silver itself was being sold for any sustained period of
time. And as long as SLV remains
relatively small, this trend ought to continue. Though SLV is large by ETF standards
(and silver standards), it is vanishingly small by stock-market
standards. The $10.2b of physical
silver bullion it holds in trust for its owners is just 0.087% (yes, less
than 0.1%) of the mammoth $11,685.8b of total capital deployed in the S&P
500 stocks alone.
And this is where SLV will really shine in the
future. What if US stock
investors, in response to this powerful secular silver bull’s huge
gains, decide to deploy just 1% of their stock capital into silver? If they do it via SLV, which is highly
likely since this ETF is so efficient and easy to trade, then
SLV could grow by 11.5x from here. Imagine what that would do to global
silver prices! What if stock
investors go to 2%? SLV, and
indeed the broader silver market, remains vanishingly small compared to
stock-market capital.
So SLV’s silver impact should only grow in the
coming years, probably dramatically.
It is a perfect vehicle to instantly and cheaply add silver exposure
to any stock investor’s portfolio.
Stock commissions and SLV’s fee are trivial compared to the huge
transaction costs inherent in physical-coin buying. SLV is also fantastic for
speculators. Not only can they
enter and exit instantly for
practically nothing, SLV has a full options chain that allows leveraged bets
on silver prices. SLV is a great
boon to all silver investors and speculators.
The biggest drawback for SLV is it doesn’t leverage silver. The best anyone can ever hope for in
SLV is whatever silver does less 0.5% annually for this ETF’s
fees. In a spectacular year like
2010 where silver rocketed 83.1% higher, this is certainly a heck of a
deal. But in general, even last
year, elite silver stocks can mightily leverage the underlying gains in
silver. One of our long-term
silver-stock investments soared over 1000% between when we recommended it in
2008’s stock panic to last autumn, compared to 200% gains in silver!
So though I’ve owned and recommended
physical-silver coins as long-term investments since silver traded near $4 in
late 2001, and I think SLV is a super-awesome trading vehicle, most of my
silver capital is deployed in high-potential silver stocks. Their gains over this secular bull
have and will continue to dwarf silver’s. And unlike options, great silver
stocks have no expiration dates and aren’t constantly bleeding time
value. Silver stocks offer the
best bang for your buck by far in
this silver bull!
At Zeal we recently finished a 3-month deep-research
project on silver stocks. We
started with the universe of nearly 100 trading in the US and Canada, and
spent several-hundred hours painstakingly whittling them down to our dozen
favorites. We published
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The bottom line is SLV has become a juggernaut in
the silver world, a force to be reckoned with. Silver investors and speculators,
regardless of whether or not they own SLV, can only ignore this ETF at their
own peril. Stock-market investors
have aggregate pools of capital vast beyond imagination, and SLV opened up
the first direct conduit in history between them and silver. The
results have been fun to watch.
SLV’s already-large impact on silver prices
should only grow. Relative to
their stock-market capital, stock-market investors’ silver exposure
remains vanishingly small. Thus
SLV has nearly endless room to grow more popular, shunting tens of billions
of more dollars into the physical silver market. And so far, stock investors as a group
have not been quick to dump their SLV shares even in big silver
selloffs. This is a very bullish
omen for SLV’s future impact on silver.
Adam Hamilton,
CPA
Zealllc.com
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Questions for
Adam? I would be more than happy to address them through my
private consulting business. Please visit www.zealllc.com/adam.htm for
more information.
Thoughts,
comments, or flames? Fire away at zelotes@zealllc.com.
Due to my staggering and perpetually increasing e-mail load, I regret that I
am not able to respond to comments personally. I will read all messages
though and really appreciate your feedback!
Copyright 2000
- 2006 Zeal Research (www.ZealLLC.com)
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