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Silver is no doubt tiny on the grand commodities scale.
But its attractiveness, spearheaded by a 1000%+ bull-to-date gain to its
latest high, has spawned a wide range of products for investors to partake
in. And one of the most unique and powerful is the SLV iShares
Silver Trust ETF.
This ETF’s objective is quite simple, to mirror
the price of silver (minus a small management fee of course). But while
simple in its objective, two unique traits have allowed SLV to take the
silver market by storm. First is SLV offers a bridge for stock-market capital
to track the price movements of a high-flying commodity, which historically
had only been an arena for the futures guys. And second is it uses this
capital to buy the physical metal.
SLV is asset-backed by silver bullion. So
not only is a share of SLV equivalent in value to an ounce of silver, it is
backed by a physical ounce of silver that is sitting in a big vault
somewhere.
The mechanics of this ETF are of course a little more
involved given its asset-backed model. As opposed to other commodities
ETFs/ETNs that simply track a price via rolling futures contracts, SLV needs
to manage a physical inventory. And managing a physical inventory to balance
day-to-day demand/supply differentials, while tracking a price, is tedious.
In order to track the price of its underlying asset,
SLV’s demand/supply needs to be equalized on a daily basis. And in
order to counteract differential buying and selling pressure, SLV actively
buys or sells bullion. This daily equalization is of course successful per
SLV’s rules, otherwise this ETF would decouple from the price of
silver.
On the buy side, by nature this ETF faces situations
when there are more buyers than sellers. When this happens for regular
stocks, it translates into a price that keeps rising until a balance is
found. And in SLV’s case this would be fine if its rise paced
silver’s. Perfectly pacing a commodity’s price is impossible in a
stock-trading environment though. And quite often SLV is in the situation
where differential buying pressure would quickly lead to an upside decoupling
from silver if it was let be.
SLV thus needs to counteract this upside decoupling by
issuing new shares (in 50k-share blocks), and then using the proceeds of
these shares to buy silver bullion. The new shares serve to effectively
absorb the excess demand. And at the end of the day this keeps SLV from
rising at a faster pace than silver.
On the sell side SLV can obviously see more sellers
than buyers on any given day. But if differential selling pressure is not
controlled, there would be a risk of decoupling from silver to the downside.
In order to prevent this SLV has to buy back shares (again in blocks of 50k).
And in order to raise the cash to buy back these shares, it needs to sell an
equivalent amount of silver bullion. This process effectively absorbs an
excess supply of SLV shares.
And provocatively this ETF’s market activity can
have a material impact on silver’s fundamentals. Since
SLV’s tracking mission shunts stock-market capital directly into (and
out of) the physical metal, it affects the real-time supply and demand of the
physical market, and thus silver’s price. And since this ETF is very
transparent with its daily activity, a simple chart can show us just how
relevant SLV can be to the silver market.
On the left axis is SLV’s net asset value. This
value (in billions of dollars) is calculated by simply multiplying
SLV’s daily holdings by the daily price of silver. And if SLV is indeed
successful in its mission of tracking the price of silver, this red line
should be a mirror image of what you’d see on a silver chart. Slaved to
the right axis, in blue, are SLV’s holdings (in millions of ounces).
To get a sharper picture of the most recent years, this
chart only goes back to 2008. But it wasn’t too long before this, in
April 2006, when this ETF was born. And folks may recall its mixed reception
at the time. While the majority of investors and silver bulls were excited
for SLV’s launch, there was opposition from industrial consumers.
Though their fears were righteous for the most part (supply coming off the
market and thus driving up prices), there was no stopping investors’
craving for this exciting trading vehicle.
And the immense interest in this ETF was apparent right
off the bat. SLV’s holdings rose five-fold (to 100m ounces) within 4
months of its launch. And they even rose during a long silver consolidation
that lasted well into 2007. From the beginning of this chart you can then see
SLV’s differential buying pressure continuing, and not really letting
up until several years later.
This huge growth period to SLV’s 2011 peak was
really quite spectacular. And perhaps the most spectacular part was a growth
in the holdings amidst 2008’s infamous stock panic. This growth showed
remarkable resiliency for this metal during a time when traders wanted nothing
to do with anything that wasn’t cash.
Coming out of the panic and into the recovery period,
SLV’s holdings surged. And in two years from the beginning of 2008,
SLV’s silver booty doubled to 300m ounces. 300m ounces is a lot
of silver! How much? The average larger-scale silver mine produces about a
hundredth of this amount, over the course of a year. In fact, 300m ounces is way more than the
combined production of all the primary silver mines in the
world over the course of a year.
SLV’s impact on silver’s overall supply
chain is actually quite substantial. In 2011 for example, the total silver
supply was around 1.0b ounces from all sources (the highest ever).
SLV’s hoard represents 30%+ of an entire year’s
supply. And it ends up being about 5% of the world’s silver supply over
the last 6.5 years (since SLV’s inception).
I really doubt SLV’s custodians could have
imagined that its holdings would climb this high, this fast. And because of
this, there is no doubt that SLV has made a material impact on the silver
market’s supply and demand fundamentals. I really don’t believe
silver prices would be where they are today if SLV hadn’t taken so much
of this metal off the market.
This ETF can however be a double-edged sword. Whereas
SLV’s shunting of stock-market capital into silver no
doubt gooses the silver price, shunting stock-market capital out of
silver can certainly have a negative effect on the price. And this is
something we witnessed in the action that followed SLV’s 366m-ounce
peak in April 2011.
This peak of course corresponded with silver’s
wild parabolic ascent that climaxed at $48+ just days after SLV’s top.
And SLV’s differential selling pressure following this top led to an
inventory draw of a whopping 61m ounces
over a period of only about 2 months. Silver was down a gut-wrenching 24%
over this exact same period of time, and I have no doubt that SLV’s
bullion purge added fuel to the selling fire.
Interestingly ever since that big draw that took SLV
back down towards 300m ounces in June 2011, we’ve seen a much different
ETF. SLV’s holdings have actually meandered within a relatively tight
horizontal consolidation band for the better part of 1.5 years now, with the
centerline average at about 313m ounces. While SLV has held strong over a
spell where silver has trended down a bit, this lack of growth points to a
muted interest in silver from stock investors.
Ultimately I suspect that SLV’s flat-grinding
consolidation is merely a holding pattern that will soon yield to a
continuation of growth. For most stock investors, both retail and
institutional, this ETF is the only way they’ll ever own silver. And I
fully expect silver’s investment demand to continue to soar as more and
more folks add this valuable component to their portfolios.
One thing that will offer confidence to investors is
SLV’s valuation, which as an asset-backed ETF it is pegged to the
net-asset value of its silver bullion holdings. SLV has made a lot of
progress since it was born to the markets as a sub-$300m concept. Its
valuation had increased 10-fold by early 2008, and it has
since grown to become one of the world’s premier asset-backed ETFs.
Of particular interest on the valuation front was
SLV’s huge growth spurt from September 2010 to April 2011. Over this
stretch SLV saw a 70m-ounce bullion build coupled with a silver price rise
of about 150%. And this led to SLV’s net-asset value soaring by a
staggering 233% before peaking with silver.
While SLV’s valuation has since come down,
it’s been relatively stable in the $10b range over the last year or so.
And this $10b valuation takes SLV well out of the small-cap realm to qualify
it for investment capital that only targets mid-cap and higher. SLV has
become the wide-reaching vehicle that the silver sector desperately needed.
And speaking of vehicle, SLV’s incredible growth
has made it one of the largest silver-related stocks out there. Of all the
primary silver vehicles, only elite streaming company Silver Wheaton and
global #1 silver miner Fresnillo PLC have larger
market capitalizations.
The vast majority of the world’s biggest and best
silver-mining stocks actually have much lower valuations than SLV. And
interestingly I’m sure this fact irks a fringe group of folks who
initially opposed SLV due to concerns that it would divert capital away from
the mining stocks.
In actuality most silver bulls completely disagree with
this minority opposition. While SLV may indeed have drawn some
capital away from the mining stocks, it probably isn’t much. In
reality, SLV isn’t in competition with these stocks. They are completely
different in what they offer investors.
SLV and mining stocks are of course interrelated in
that the miners won’t thrive without a strong silver price. But in
isolation SLV is a direct play on the price of silver, whereas the mining
stocks are leveraged plays on the profits of the miners.
SLV and mining stocks also sport vastly different risk
profiles. SLV is inherently risky being pegged to a small-market volatile
commodity. But the mining stocks carry silver’s innate risk and
company-level risk. When you add operational, geological,
geopolitical, and other risks that mining companies bear, you’ll find
that mining stocks carry much higher risk.
I really believe that the majority of investors who own
SLV would not be invested in this sector at all if this ETF didn’t
exist. It’s not a matter of SLV’s shareholders choosing this ETF
over mining stocks. It’s SLV, or nothing silver-related. Besides, it’s
a different class of traders who choose mining stocks.
Those of us who traffic in the mining-stock realm have
a greater appetite for risk, of course with the hopes that there will be much
greater rewards. These stocks offer huge positive leverage to silver, which
over the course of silver’s bull has led to legendary gains. Even in
silver’s latest upleg, the mining stocks
easily outpaced SLV!
If anything SLV has made things better for the miners.
There’s no denying SLV’s big role in rising silver prices. And
these higher prices allow the miners to generate higher margins. SLV is a
win-win for miners and investors!
And not only do I not believe that SLV is cannibalizing
mining-stock capital, I don’t believe it cannibalizes retail physical
investment either. Prudent investors realize that SLV should never be used as
a substitute for owning the metal in one’s physical possession (which
at Zeal we’ve long recommended as a foundational component of
one’s portfolio). SLV is a neat vehicle that has added an entirely new
component to silver investment and speculation.
At Zeal we’ve been huge silver proponents since
this bull’s beginnings. And we certainly endorse SLV to risk-averse and
new-to-silver investors, as well as traders playing the options markets. But
when silver prices are going up, we definitely prefer the huge potential
offered by the mining stocks.
In our acclaimed weekly and monthly newsletters,
we’ve been loading up on quality silver-mining stocks in anticipation
of what we expect to be a strong silver upleg in
the coming months. To find out which stocks we’re recommending, in
addition to our famous contrarian market analysis, subscribe today!
And if you’re a stock-hound who would be well
served getting deeper analysis on individual mining stocks, we offer in-depth
research reports that
profile our favorite stocks in high-potential sectors. It so happens that our
latest effort is a fascinating 29-page report that profiles our favorite 12
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The bottom line is SLV has grown to become a force in
the silver world. This unique ETF offers stock investors an unprecedented
opportunity to trade, and effectively own, one of the most exciting
commodities out there. And its popularity has made SLV a vast storehouse of
wealth that has had a major impact on pricing.
Though SLV hasn’t actually taken much silver off
the market over the last year and a half or so, there is no denying its
impact since inception. And when silver starts to rock once again, SLV ought
to see a healthy flow of stock-market capital that will boost its holdings
while accelerating silver’s momentum. SLV is a great option for
investors, and it offers a bridge to the more dynamic mining stocks.
Scott Wright
November 2, 2012
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Thoughts,
comments, or flames? Fire away at scottq@zealllc.com
. Depending on the volume of feedback I may not have time to respond
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2000 - 2012 Zeal Research (www.ZealLLC.com)
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