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John Hathaway: A speculation on gold and the credit cycle
By Theodore Butler
InvestmentRarities.com
Tuesday, June 28, 2005
There has been much commentary recently concerning a prospective
silver exchange- traded fund (ETF), culminating with the announcement
that Barclays had filed with the U.S. Securities and Exchange
Commission for permission to offer such a fund.
Make no mistake; this is big news for silver. And, in my opinion, it
will be only good news regardless of the actual final outcome.
Already a debate has developed about whether a silver ETF will garner
sufficient investment demand, to how much impact a silver ETF will
have on silver, to just how much impact even the talk of a silver ETF
has already had on the price of silver. Before we get into these
obvious issues, and some other not so obvious issues, it would be
appropriate to discuss just what an ETF is all about. But let me give
you my conclusion up front -- this will be another reason to secure
an investment in real silver.
For those who may be unfamiliar with the workings of a commodity ETF,
here is a very simple explanation, using data from the preliminary
prospectus that Barclays filed for its proposed silver ETF:
http://www.sec.gov/Archives/edgar/data/1330568/000119312505127244/ds1.
htm
To establish a commodity ETF, a financial institution buys and stores
a quantity of the commodity in question and then issues shares of
common stock at a fixed unit of conversion to represent fractional
ownership of that commodity. In the case of silver, Barclays would
buy the metal, in industry-standard thousand-ounce bars, have them
stored in London and elsewhere, and issue common stock shares in a
ratio of one share of stock for every 10 ounces of silver. The shares
would then be traded on a recognized stock exchange -- hence the
name, exchange-traded fund.
In the case of the Barclays Silver ETF, the exchange would be the
American Stock Exchange. They've even decided on the stock
symbol, SLV.
The amount of silver bought and stored would increase and decrease
depending upon the investment demand for the shares, similar to how
the gold ETFs currently function.
I'm going to avoid a detailed discussion of peripheral matters like
tax treatment and the fine points of the Barclays prospectus, and
concentrate on the big picture. I'm going to avoid any discussion
that this proposed offering may not be completely aboveboard and that
the real silver proposed to be bought may not actually be purchased,
or that this may be some type of subterfuge or trick.
That would be preposterous, in my opinion. After all, there is a blue-
chip roster of well-known names behind this offering. Besides
Barclays is the sponsor, the Bank of New York is the trustee, and
JPMorganChase (London branch) is the custodian of the silver.
The advantages of a silver ETF are obvious and powerful. It is common
knowledge that you get great physical bulk relative to the amount of
money when you buy real silver. For large amounts of money,
professional storage arrangements must be arranged. Even after the
price increase of the past couple of years, $100,000 worth of silver
still weighs about a thousand pounds. Thought must be given as to
where one actually puts a half ton of metal.
A silver ETF answers that question.
(It should be noted that professional silver storage can be arranged
without an ETF, so the Barclays proposal doesn't break new ground in
that regard.)
Another advantage of a silver ETF is that it will open real silver
investing to entities heretofore precluded from such investment, by
virtue of its common stock format. Here I am talking most
specifically about retirement accounts of all types, both retail and
institutional.
Also, a big advantage to a silver ETF would be tremendous liquidity,
tight bid/ask spreads, and low commissions. An investment vehicle
that makes real silver investing this easy could have profound
effects on potential demand.
When you think about it objectively, a silver ETF makes a lot of
sense. In fact, it makes a lot more sense than does an ETF for gold,
of which there are already several in existence, just from the need
for professional storage. After all, the same $100,000 that equates
to a thousand pounds of silver weight equates to only 15 pounds of
gold. One would think that relatively large dollar amounts of gold
could be held without the same need for professional storage as
silver. Yet the gold ETFs have been very successful, with the two
leading US-traded versions holding more than 6 million ounces, or
more than $2.7 billion worth of gold.
Therefore, it is hard not to get excited about the prospects for a
silver ETF -- the obvious reason being what impact ETF purchases of
real silver would have on the price.
The Barclays prospectus lists a proposed total offering of 13 million
shares of stock, which equates to 130 million ounces of silver, or $1
billion. From a dollar perspective, the offering seems reasonable, as
it is only a fraction of the dollar amounts of the comparable gold
ETFs. But the comparison becomes warped from there.
I don't know what the Barclays people are smoking to suggest that
they could buy 130 million ounces of silver at anywhere near current
prices. That 130 million ounces is an interesting amount of silver.
It just about equals the total known world silver bullion inventory.
In gold, the 6 million ounces in the two big gold ETFs amounts to
maybe 1 percent of known gold bullion equivalent inventory.
That's why the gold ETFs haven't had much impact on price, even
though billions of dollars worth of gold have been bought. There is
an enormous amount of gold in the world, certainly compared to
silver.
The amount proposed in the Barclays prospectus equates to 100 percent
of known world silver inventories.
You don't have to be Albert Einstein to realize buying 100 percemt of
something will have a greater impact on price than buying 1 percent
of something.
I ask you to recall the repeated delays that the Central Fund of
Canada experienced in its purchases of silver (never for gold) over
the past few years. Here we are talking about several million ounces
of silver not being delivered for months and months, and not tens of
millions or 100 million ounces, or more. And there have been repeated
delays in COMEX silver deliveries, although certainly not to the
point of default.
Regarding my reading of the Barclays prospectus, I see no allowance
for delivery delays. If there is demand for the shares, the silver
must be purchased immediately. What would that do to the price?
One hundred thirty million ounces is also interesting in that it is
the amount of silver bought by Warren Buffett's Berkshire
Hathaway eight years ago, which caused silver prices to double in
price.
Public statements at that time indicated that Berkshire never even
received delivery of the full amount purchased. And please remember,
as Berkshire made clear at the time of its silver purchase, it was
very careful to try not to disrupt the price or the silver market, by
taking its time (six months) and buying only on price pullbacks and
never on new highs. And still the price almost doubled.
I see nothing in the Barclays prospectus suggesting such buying
restraint, either in time or price.
You have to wonder, after eight years of continuous deficits and the
resultant depletion of silver inventories, just how much silver the
Barclays ETF could actually get delivery of and at what price.
Certainly the silver will not be bought from current production, as
the prospectus makes abundantly clear in documenting the structural
silver deficit. But I sincerely hope they do get to try.
What is most uncertain is the timing of the proposed silver ETF.
Published reports indicate it may take a year or longer for the
prospective offering to become effective. My suspicion is that it
will take somewhat longer -- say, sometime around the 12th of never.
While I genuinely hope that I am wrong and Barclays gets to launch
this silver ETF with its resultant impact on the silver price, my
common sense tells me it is not to be. Even for lesser amounts. Let
me tell you why.
Aside from the absurdity of proposing to buy the entire known
inventory of any world commodity and what that would do to prices, it
would be equally absurd to assume that officials from the SEC and
CFTC would allow such a scheme.
As you know, I am not a big supporter of how the government has
regulated the silver market, but it would be unreasonable to assume
that they would let this scheme slip by.
I know there is proposed ETF covering oil, but that has not and may
not be approved, and does not propose buying real oil, just futures
contracts. I am also aware of an actual uranium commodity security
(effectively an ETF) in Canada, but that is out of the jurisdiction
of U.S. regulators and uranium is not a widely traded commodity.
I think it would be a mistake to assume that U.S. regulators would
give carte blanche to silver and other commodity ETFs. I know when I
put myself in their shoes, approving a security that would impact the
price of a commodity would be the last thing I would do. Gold was a
special circumstance, because they knew there was so much gold in the
world.
Let me be clear -- I think the general idea of a silver ETF is a
great, as I have previously written. I recall suggesting on several
occasions, both privately and publicly, for instance, that the
Central Fund of Canada should offer a silver-only fund. I still think
that's a good idea, especially considering that fund's previous
track record and non-US jurisdiction. But slow and steady
accumulation should be the guideline, not all at once. How anyone
could expect the regulators to sit idle and watch any market be
disrupted by sudden concentrated purchases of enormous quantities is
beyond my comprehension.
Of course, it is possible that I am giving the regulators way too
much credit in assuming they will see clearly the artificial impact
this particular ETF would have on the silver price. I suppose it
could occur that they will prove to be just as out to lunch on the
proposed silver ETF as they've been on the blatant silver
manipulation for the past 20 years. All we can do is wait and observe.
I can't help but feel that the Barclays people have rushed to market
the first silver ETF, since they were late in coming to market with
their gold ETF, and have suffered being relegated to a distant second
place in that market. As it stands, being out of the gold gate late
has cost them dearly, as their gold ETF amounts to less than a tenth
of the size and volume of the leading gold ETF. But haste can
sometimes make waste. I understand that Barclays is supposedly a
leader in bringing ETFs to market, but I question their knowledge of
the silver market.
But the Barclays filing is good news for silver investors, regardless
of the outcome. This silver ETF announcement is a true win-win for
silver investors.
In the event I am wrong and their silver ETF becomes effective, the
impact on the price of silver will be great. That's win No. 1,
obvious and straightforward.
But if I'm correct and this ETF never sees the light of day, that
will be a big win as well for silver investors.
Why?
Because it will prove for all to see just how critical the
supply/demand and inventory situation is in silver. If the government
says "no way" to this ETF, it will be for one reason only: There is
not enough real silver in the world to fund it. There will be no
other way to spin it.
In any event, Barclays has done the silver world a great favor,
albeit unwittingly. They have created what should be a watershed
event. Their silver ETF is in play and out in the open. It will now
come to market or it won't. If comes, that's good. If it doesn't,
that's good too. For the real silver investor, either outcome is good
news.
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Ted Butler silver commentary archive:
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