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August 22, 2008

Silver Arbitrage
by David Morgan

In economics and finance, arbitrage is the practice of taking advantage of a price differential between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices. When used by academics, an arbitrage is a transaction that involves no negative cash flow at any probabilistic or temporal state and a positive cash flow in at least one state; in simple terms, a risk-free profit. An entity such as a bank or brokerage firm that engages in arbitrage is called an arbitrageur. The term is mainly applied to trading in financial instruments, such as bonds, stocks, derivatives, commodities, and currencies. (Source Wikipedia.)

There is without a doubt a price differential between retail silver product such as 100-troy-ounce silver bars and the spot price for silver on the Futures Exchange. In fact, this presents a very good arbitrage opportunity for those willing to take the risk. This is accomplished by selling lots of 1000 troy ounces in 100-ounce bar increments and locking in the 1000-oz. Comex bars for delivery. This process is achievable and like all arbitrage situations will find some market participants willing to take advantage of this opportunity.

The spread has been sizeable and over time should narrow, thus making this arbitrage successful. To my knowledge there are very few manufacturers of 100-ounce silver bars. Johnson Matthey in Salt Lake City still produces them and the North West Territorial Mint produces 100-oz. bars with the Pan American Silver Hammer logo. Is it difficult to buy 100-oz. silver bars? Absolutely!! Are we short of silver? Not necessarily, but most retail precious metals investors at this time wishing to lock in these prices are finding it extremely difficult.

In my view, this presents an opportunity for someone with the ability to secure a source and/or manufacturer of 100-ounce bars, silver rounds (1-oz. medallions), and perhaps 10-oz. silver bars, using 1000 Comex grade bars as the source.

Personally, I took a somewhat different tack, not necessarily an arbitrage, per se, but what I call the ratio spread. See chart below.

We can see from this weekly chart that gold clearly outperformed silver from 1999 until 2003. The gold/silver ratio reached a high near 82 to 1 in early 2003. The trend has been down since then, meaning that silver has outperformed gold from 2003 to present, but not by much.

If we study this chart carefully, we see that silver has very recently jumped far outside the channel formation that I have drawn. To my thinking, this represents an opportunity to trade gold for silver. This is exactly what I did on August 19, 2008. The actual swap took place near the 62 to 1 ratio, and I expect the ratio to fall back into the channel formation and in the years ahead to continue its downward bias. This channel formation can also be used to swap silver back into gold, which is what I plan to do at some point in the future. This certainly is "trading," but not in the traditional sense; it is physical reality -- real metal is being handed across the counter.

Time will tell whether this proves to be a good trade or not, but from my perspective it looks too good to pass up.

In closing, most markets close arbitrage opportunities rather quickly. Therefore, those who wish to take advantage of the opportunity must take action. Will silver be any different? Time will tell....

It is an honor to be,

David Morgan
Silver-Investor.com

Mr. Morgan has followed the silver market daily for over thirty years. Much of this Web site, www.silver-investor.com, is devoted to education about the precious metals.

Mr. Morgan has been published in The Herald Tribune, Futures magazine, The Gold Newsletter, Resource Consultants, Resource World, Investment Rarities, The Idaho Observer, Barron's, and The Wall Street Journal. Mr. Morgan does weekly Money, Metals and Mining Review for Kitco. He is hosted monthly on Financial Sense with Jim Puplava. Mr. Morgan was published in the Global Investor regarding Ten Rules of Silver Investing, which you can receive for free. His book Get the Skinny on Silver Investing is available on Amazon or the link provided. His private Internet-only newsletter, The Morgan Report, is $129.99 annually. To suscribe to the Morgan Report click here.

Information contained herein has been obtained from sources believed to be reliable, but there is no guarantee as to completeness or accuracy. Because individual investment objectives vary, this Summary should not be construed as advice to meet the particular needs of the reader. Any opinions expressed herein are statements of our judgment as of this date and are subject to change without notice. Any action taken as a result of reading this independent market research is solely the responsibility of the reader. Stone Investment Group is not and does not profess to be a professional investment advisor, and strongly encourages all readers to consult with their own personal financial advisors, attorneys, and accountants before making any investment decision. Stone Investment Group and/or independent consultants or members of their families may have a position in the securities mentioned. Investing and speculation are inherently risky and should not be taken without professional advice. By your act of reading this independent market research letter, you fully and explicitly agree that Stone Investment Group will not be held liable or responsible for any decisions you make regarding any information discussed herein.

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