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April 20, 2007

Bring on the Empty ETFs?
by Roland Watson

Bring on the Empty ETFs?

This week has been a busy week for silver as announcements of two silver ETFs were made to the media. When I read the words "silver" and "ETF" I was part hoping it was finally the silver stocks ETF I mentioned in the latest issue of my newsletter. However, it was not to be as the third silver ETF was announced by the Zurich Cantonal Bank along with their platinum and palladium ETFs. It will start trading on the 10th May.

I asked for the prospectus and got some documents in German. I ran it through Google translator and got some extra items of information.

• This is an ETF targeting institutional and high net worth investors. Further information suggests it is only available to Swiss investors.

• It is also not bought via shares but by physical ounces. The silver is stored in 30kg bars which presumably equates to the 1000oz bars held by the Barclays silver ETF.

• Subscribers to the ETF can also take delivery of the physical metal they have previously bought but only in 1000oz bars.

• Also for the bears, the ETF can be shorted.

Going by the size of their already running gold ETF ($380M or about 560,000 ounces of gold), I don't expect it to outdo the Barclays silver ETF. At a gold silver ratio of 50 that equates to 28 million ounces of silver, far less than the 135 million ounces currently with Barclays. So this ETF seems more limited in scope than the Barclays ETF, but nevertheless shows the continued interest that is being generated in the realm of precious metals investment.

Now no sooner had I completed my thoughts on this ETF than a fourth silver ETF was announced to investors the next day! This announcement came from the London based ETF Securities who will be setting up ETFs for gold, silver, platinum and palladium each backed by physical metal. There will also be an ETF which is a mix of all four metals. The firm denotes these physical metal vehicles as Exchange Traded Commodities (ETCs) rather than Exchange Traded Funds (ETFs). This is perhaps to distinguish them from the silver ETF and others that ETF Securities already run. Their current silver ETF is not backed by physical but merely tracks the price of silver using the DJ-AIG Silver Sub-Index. The two are distinguished by the titles ETFS Physical Silver and ETFS Silver.

So now silver investors have the choice of the Barclays ETF, the Zurich ETF and the ETFS ETF and ETC run from London. However, some may say that none of the above holds physical silver.

My aforementioned German translation says this:

"The ZKB Silver ETF exclusively invests into physical silver."

and

"Contrary to existing ETFs, for which usually a basket of shares is the basis, the ZKB silver ETF invests only in physical silver."

Is this implying that the Barclays silver ETF doesn't have any physical silver? I don't think it does unless ZKB like collecting lawsuits as a hobby. The first quote is merely saying that the ZKB silver ETF only holds physical silver and does not hold silver by proxy (e.g. derivatives, equities). The second quote is simply stating that their ETF is denominated in a different manner - ounces instead of shares. It is highly unlikely that one major bank would accuse another bank of silver subterfuge in their promotional literature!

But let us address the "empty ETF" theory. The Barclays silver ETF started trading on Friday 28th April 2006. Three weeks later, silver plunged from $15 to $9.50 and to this day has meandered between those two prices. Silver investors who are open to conspiracy theories blame the ETF. In fact, a recent article on the web suggested that the ETF is a fraud instrument to divert money from physical silver and also provide cash for the shorts to beat down silver more.

In my opinion this theory is wrong. People who specialize in gold tend to map their gold arguments onto silver. So if gold is perceived as being "managed" then so must silver. This is not so - even if gold was being micromanaged by government agencies and proxies.

The truth of the matter is that Barclays have every darned ounce they claim to have apart from when they have to hold a little cash and extract their admin fees. The problem for conspiracy theorists was when Barclays accumulated 130 million ounces without causing a default in the silver markets. Some thought this wasn't possible due to their perceived supply constraints in the silver market. This is an example of theory dictating to the facts rather than the other way round. Instead of accepting this, some people created "hidden" facts such as empty ETF vaults to nullify the open facts.

So what about the supposed non-appearance of a silver default? It wouldn't have escaped people's attention that silver had more than tripled in price since June 2003. Why had silver tripled in price? It had tripled because increasing demand has been putting pressure on supply hence the market adjustment in price to bring more silver to the marketplace to rebalance supply-demand. What does that tell us?

Basically, a silver supply constraint is not defined as silver at $50, $100 or more. It is defined as a sustained rise in the silver price. It is not defined by how long it takes to take delivery of physical silver; it is defined by an increasingly more expensive price. In other words, the silver supply problem is already here - it just arrived quietly and not with a sonic boom as some expected. So don't pick price targets, just go with the market flow and make your profits.

Now I don't know about anyone who didn't get their silver if they waited long enough and a delay is not a default. If you want to see a real default, check out the recent nickel market problems in London where defaulted contracts had to be settled in cash. This has not happened in the silver markets.

I have never had a problem getting hold of bars and coins - but I sure had to pay more for them as others jumped into the silver investor category. Indeed, the well known Goldmoney and CEF funds hold over 40 million ounces of silver and counting between them! Expect these funds plus the three ETFs mentioned to bring the silver haul into the hundreds of millions of ounces as this silver bull progresses.

Now all this does not mean that there will be no future crisis in the silver supply-demand balancing act, I believe there will be but for now the silver supply problem is no different to other commodity supply issues we are currently witnessing, albeit very profitable and easier to invest in (how many copper ETFs are there?).

But it is a supply problem nevertheless. Indeed, when ETF Securities announced their platinum ETC, the reaction by platinum producers produced another proof of why the Barclays silver ETF has all the silver it claims to have. The world's biggest platinum producer is Angloplat and it was sufficiently concerned about potential supply problems to state that it would not be providing metals for the platinum ETC.

Does this not remind us of the Silver Users Association who tried to get the SEC to reject the filing for the Barclays Silver ETF last year? Now if this ETF was a conspiracy to keep the shorts happy with a suppressed silver price, then why would the SUA try to get it stopped? The answer is simple; they knew it would be holding real physical silver in vast quantities and hence adding fuel to a silver price rise. So much for the silver shorts seeing this ETF as a brake on silver prices. In fact, not a few commentators thought a silver ETF could be a non-starter because of the potential disruption to supply. That so far has not proven to be the case and the same will probably go for the platinum ETFs.

So what was going on with Barclays and silver? Here is an alternative theory to what Barclays did before and after the ETF launch. It is as good as any conspiracy theory and probably just as improvable!

Up to a year before the ETF launch, I suggest Barclays were acquiring or placing orders for large quantities of silver while silver was still relatively cheap. Whether they did this through the futures market or direct from refiners, I don't know. They knew the silver bull was real and that the ETF anticipation would add extra impetus to the silver price so they decided to get silver while it was cheap. Why did they do this? So that when the ETF launched, they would have silver bought at $7 which they would later sell to ETF investors at double digit prices. The silver investors get their silver at current market prices and Barclays pocket the difference. Perfectly legal and I applaud them for their foresight in doing this. After all, that is the same plan we silver investors have for our smaller inventories - buy low and sell high!

Eventually, Barclays slowed down their silver acquisition around launch date and demand dropped enough to catalyze a correction in the silver price. Of course, Barclays may have got all this wrong and ended up holding a mountain of silver no one wanted. But I say that Barclays being the big investment house they are would have applied standard hedging techniques to ameliorate any losses to the downside. In summary, Barclays knew exactly what they were doing and they have perhaps been doing it again during the times of $10 silver in anticipation of more buyers at higher prices. That is my counter-theory to Barclays and silver and you can take it or leave it.

Is this in fact what happened? Of course, I have no way of knowing but it makes more sense than the theory that mega-bank corporations are worried about a tiny silver market whose size is dwarfed by markets which have a much bigger say in the fragility of fiat money, inflation and the economy. The multi-trillion dollar bond market is one example.

Is the price of little ole silver important to government and big business? Why should it be anymore than the price of zinc or lead? How many people in the world follow the price of silver as an indicator of fiat money weakness? Not many I suspect. The internationally accessed BBC News website does not even list the silver price on its commodity market page.

So there is no motive to manipulate the price of silver. That may have been done in decades past to support the American mining industry and stop the silver content of coins exceeding their face value but not now.

Now is different. Silver is floating in price and by the time this current phase of the silver bull market ends, a high grade supply of 300 million or more ounces of ETF, Goldmoney and CEF silver could be available to dump onto unsuspecting investors.

Let me tell you, THAT is a more frightening thought about ETFs than any conspiracy theory can care to suggest.

Further analysis of silver can be had by going to our silver blog at http://silveranalyst.blogspot.com where readers can obtain a free issue of The Silver Analyst and learn about subscription details. Comments and questions are also invited via email to silveranalysis@yahoo.co.uk.

Roland Watson
http://silveranalyst.blogspot.com

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