Monday, April 25, 2011

One Fund = 1/3 of all Silver Bullion on Earth

From this recent Jason Zweig article in the Wall Street Journal on the iShares Silver Trust (SLV). 

The article points out that the fund is now the 12th largest ETF in the U.S. and holds (get this) one third of all silver on earth.

One fund that owns one-third of ALL the silver bullion on earth?

Geez.

The market in silver operated okay, for quite a long time, before a trading vehicle existed that owned 1 out of every 3 troy ounces of the metal.

So it seems reasonable to ask the following: Does this amount of incremental demand created by these convenient new methods of trading and owning silver cause a slight or even meaningful upward push in the metal's price?

I'd like to hear an unbiased explanation of how that kind and size of structural change doesn't impact prices.

I know that concerns over extremely loose monetary policy by central banks and the resulting lack of trust in paper currencies in general is a fundamental (and maybe even one of the dominant) driver of these price increases.

Makes sense.

That doesn't mean the invention of these (and other) relatively convenient new methods of trading commodities aren't exaggerating the moves.

Both can be true.

In addition, it has been suggested for some commodities that other factors (leverage in the system, inadequate position limits etc.) are distorting prices.

At some point down the road, with the benefit of hindsight, the actual drivers of the huge moves in commodity prices (monetary policy, supply/demand imbalances, leverage, position limits, proliferation of ETFs, etc.) will be easier to understand. There will be no shortage of strong opinions until we do. I don't know the answer. All I know is, historically, an extended period of price increases in any market starts with something fundamentally sound then gets exacerbated by excess.

So yes there are fundamental causes behind these price moves. There are, in many cases, legit supply/demand imbalances and concerns about monetary policy. Still, I won't be surprised when the dust settles if it turns out more than a little bit of these massive increases in price across the commodities complex turns out to be, in part, driven by how convenient it has become (from pension funds to personal brokerage accounts) to trade everything from gold to grains. The amount of leverage being employed will also likely be a factor (explicit or via derivatives). In short, the sheer amount of money that has flooded commodities markets used to end up elsewhere.

The above 4 ETFs are far from an exhaustive list of silver funds but all are relatively new (roughly 5 years old or less...the entire commodity ETF phenomenon began a half decade ago or so but proliferation is a more recent thing).

The newest of the silver ETFs is the Sprott Physical Silver Trust which has been around for ~6 months. Zweig's article points out the silver in the fund is worth $ 18.15/share but the market price is $ 22.11.

A 22 percent premium.

The oldest of these funds is the iShares Silver Trust at roughly five years old. I think five years or so qualifies as too little history to be making a definitive judgment about whether and how much prices are being distorted. Yet, such a small base of experience with relatively new trading vehicles that potentially wield significant influence on behavior (and ultimately prices), at the very least, warrants skepticism and open-minded caution.

What's changed is usually a good place to start in order to understand a problem.

Adam

Related posts:
Michael Masters: Commodities Complex in the Throes of a Bubble
Oil's Endless Bid
Ray Dalio on Stocks & Commodities
Financialization of Copper

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