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February 24, 2006

The Silver ETF: What's the Deal?
by Jason Hommel

Silver Stock Report

The Silver ETF continues to get a lot of coverage, as follows:

Hit With The Stupid Stick Again, By Theodore Butler, February 21, 2006
http://www.investmentrarities.com/02-21-06.html

The Silver Fund Battle Continues, Australasian Investment Review, February 21, 2006
http://www.aireview.com/index.php?act=view&catid=7&id=3600

Approaching Hubbert's Peak of Silver? By Jon A. Nones, February 20, 2006
http://www.resourceinvestor.com/pebble.asp?relid=17222

Silver Users Association Voices ETF Opposition to SEC, By Jon A. Nones, February 16, 2006
http://www.resourceinvestor.com/pebble.asp?relid=17119

SilverStockReport.com: Silver Users Fear Silver Shortage, Thursday October 27, 2005
http://silverstockreport.com/silvershortage/

Will the SEC approve the ETF? I think so. The reason is that since the gold ETF's were approved, there is little legal justification for a denial. Without legal grounds upon which to base a denial, how can the SEC deny it? The Silver User's Association's plea contained no legal basis for a denial, just a whining anti-free-market hypocritical, self-serving, short-sighted, wrong-headed, rant.

When will it be approved? I don't know.

Is it overdue? I don't think so. Barclays filed in the summer of 2005, and we might have to wait until the spring or summer of 2006!

Will it divert investment demand away from stocks? I don't think so. I think it will attract investment demand from several sources.

1. Pension funds will invest in the Silver ETF. This is the big, dumb money that can't buy the silver stocks because the market capitalizations are just too small, and because the large market cap silver stocks are all too overvalued (such as with PAAS having a P/E ratio in excess of 100).

2. IRA funds will invest in the Silver ETF. In your IRA, you cannot take possession of silver anyway, and in an IRA, your stocks and assets grow tax free and there are no tax consequences when selling. Therefore, there is no disadvantage to owning the silver ETF vs. real silver. In fact, there are two clear advantages of the silver ETF for IRA accounts: First, it will probably be more liquid, with a lower spread, thus being easier to buy than real silver. Second, if your brokerage house is untrustworthy, the Silver ETF may be more secure than your own brokerage house holding your silver in an unallocated account. Besides, IRA money cannot be used to purchase futures contracts, so the only other way to get exposure to silver is bullion, or the Silver ETF.

3. Many silver mining companies will invest in the Silver ETF. Yes, many silver mining companies are uncomfortable holding bonds and cash, and they would like to put up to $10 million into silver bullion, but the accounting nightmare and logistical nightmare prevent them from buying physical. Instead, the purchase of a Silver ETF would show up on the books very cleanly, with a nice account statement, as the money has not "disappeared" (as it were) if purchases of physical silver were made.

The best news of all is that the Silver ETF will require 130 million ounces, according to the prospectus, and there is not even 130 million ounces over at the COMEX to buy. So, that is very bullish news for silver, especially since the Silver ETF will need to buy that 130 million ounces well before the ETF is approved, so that they have the silver available so that the Silver ETF will be ready for trading when it is approved, as Ted Butler has pointed out last October.

This week, Ted Butler wrote that he thinks the silver EFT is a bad idea, because it would allow a potential "long" manipulation, because a person, or entity could go around existing commodity law, and buy large amounts of silver beyond the 150 contract limit, after which, buyers of futures contracts are supposed to reveal information about themselves, but through the silver ETF, they could remain safely anonymous. See: http://news.silverseek.com/TedButler/1140573484.php

But the nature of bullion is that the holders of it naturally remain anonymous.

And I have long maintained that it is impossible for there to be any such thing as a "long" manipulation. In a free market, in a free world, anyone ought to be free to spend their money however they wish, and to own as much of anything as they wish, including gold and silver. On January 6th, 2003 I wrote:
http://www.silverstockreport.com/essays/Open_Letter_To_the_Authorities_of_the_Silver_Markets.html

Gorham admitted that the large long position of the Hunt brothers was a manipulation of the markets, ostensibly resulting in prices that would be too high, and Gorham took pride that such manipulation (as it was called) was stopped!

I would argue that it is impossible for longs to manipulate markets in free markets because freedom means that anyone is free to buy as much of anything as they wish. That's what freedom means.

However, it should never be legal to allow people to sell what they do not have, because that is the very essence of fraud, and fraud is not to be tolerated wherever justice and free markets are enforced. A short manipulation is dangerous. It will hurt everyone who holds the commodity and who is invested in producing the commodity. Furthermore, a short manipulation ends in a short squeeze or bankruptcy and default by the shorts, the kind of default that regulators, such as you two gentlemen, are supposed to prevent.

If there are limits, then men are not free. Period. End of discussion. Yes, this means that the laws prevent men from being free. The laws against a "long manipulation" in the current system only exist to support of the fraud of the paper dollar.

Nevertheless, I have had serious doubts about the Silver ETF. I have three main concerns:

First, the big problem is that the custodian of Barclays' physical silver is J.P. Morgan, who is a bullion bank named in the lawsuit against Barrick by Blanchard. I assume J.P. Morgan is short both silver and gold (they likely mostly owe, not own, silver and gold, and stand to go bankrupt if bullion prices rise substantially). As some have said, having J.P. Morgan as a silver custodian is like putting the mouse in charge of the cheese.

My second concern is that it is easier to steal silver if it is concentrated and held in one location. If silver ownership is ever made illegal, then the silver held in the Silver ETF is clearly most available for confiscation--and, in fact, it would probably not be able to prevent its confiscation. In contrast, silver held privately, is infinitely more difficult to track down and confiscate.

But silver bullion held in safe deposit boxes is similarly vulnerable to confiscation. Even so, confiscation is really not much of a concern until and after silver rises in price well above $1000/oz., for the mere fact that there is not enough of it to attract the attention of a government that spends over $2 trillion per year. All the gold in all the world is barely more valuable than $2 trillion per year, so if gold is not worth confiscating, neither is silver!

A third reason for suspicion is that the Silver ETF could buy silver futures contracts to excess, which would be manipulative. Practically speaking, a silver ETF must be allowed to trade in silver futures contracts, due to the size. There is no other way to accumulate as much silver as the ETF would require, without buying it from the COMEX through futures contracts. It's not necessarily manipulative. However, if the silver ETF could hold either physical silver, or paper silver, then the very structure lets the door wide open for abuse.

The silver ETF managers could take your full money, and buy one silver long to satisfy the requirements of the Silver ETF, and then, take the rest of the money, and go short numerous paper contracts to keep down the price (in theory). Or, the silver ETF could use your money to buy silver bullion from the market. Then, they could lease this silver into the market, and hold a silver futures contract instead. And, with the difference, they could go short silver, so as to move the market down, and not be liable for as many paper dollars as they would owe to the silver long who bought a Silver ETF share!

Or, the owners of the Silver ETF could buy two or more long contracts for every contract needed to satisfy the requirements of the ETF, and thus, make over 100% as much money as the people who put their capital into the Silver ETF. But the poor holders of the Silver ETF would be exposed to all the risks of a default on silver futures contracts, without the potential leveraged gains.

So, owning a silver ETF through your IRA account is owning a paper promise (from your broker) that they hold a paper promise (from Barclays) who may hold yet still another paper promise (from J.P. Morgan bullion custodian). That many paper promises stacked on top of each other is not very comforting when the entire reason for owing bullion in the first place is to prevent the loss of capital from cascading cross defaults!

Personally and practically speaking, despite all my reservations, concerns, and potential problems, I would probably buy the Silver ETF (to hold temporarily and short term) in my IRA account, rather than own dollars in the IRA. I must own something if I don't own a silver stock! (Some silver investors seriously recommend taking the money out of your IRA now, because taxes deferred can change and become much higher!)

And so, due to the overall risk in the entire financial system, I plan on moving more and more of my capital into physical bullion as this bull market in precious metals develops. Always remember to take profits from your stocks in the form of physical bullion that is in your own possession. You don't control the silver or gold unless it's in a safe that you own--the combination to which only you know. Any other type of "control" is really just another man's promise, and the beauty of gold and silver is that it is not a promise, it is true and honest and real payment in full!

I'm neither a dealer, nor broker. I'm an investor and a writer. If you need a dealer or broker, and can't find one in your phone book, see below:

A Brief Guide to Buying Silver
(List of bullion dealers)
http://www.silverstockreport.com/buybullion.htm

Need a Broker that can handle Canadian issues and/or pink sheets?
(List of stock brokers)
http://www.silverstockreport.com/brokers.html

For a list of names of about 80 silver stocks (very outdated, from July 2005) see
http://www.silverstockreport.com/reports/silverstockreport57.html

And if you want to see where I've put my money, you can buy the "look at my portfolio" which I offer at silverstockreport.com.

Jason Hommel
SilverStockReport.com