WEEKLY COMMENTARY

June 28, 2005

THE COMING SILVER ETF?

By Theodore Butler

(The following essay was written by silver analyst Theodore Butler. Investment Rarities does not necessarily endorse these views, which may or may not prove to be correct.)

There has been much commentary recently concerning a prospective silver Exchange Traded Fund (ETF), culminating with the announcement that Barclays had filed with the US Securities and Exchange Commission (SEC) for permission to offer such a fund. Make no mistake; this is big news for silver. And, in my opinion, it will only be 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 upfront – 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

In order 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 1000 oz bars; have them stored in London and elsewhere, and issue common stock shares in a ratio of one share of stock for every ten 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 certainly 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 as 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 1000 lbs. 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 1000 lbs of silver weight, only equates to 15 lbs 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 over 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. 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% 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% of known world silver inventories. You don’t have to be Albert Einstein to realize buying 100% of something will have a greater impact on price than buying 1% 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. As far as 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?

130 million ounces is also interesting in that it is the amount of silver bought by Warren Buffett’s Berkshire Hathaway, 8 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 and not disrupt the price or the silver market, by taking its time (6 months) and only buying 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 8 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 12^th 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. US regulators and uranium is not a widely traded commodity. I think it would be a mistake to assume that US regulators would give Carte blanches 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, both privately and publicly, for instance, that the Central Fund of Canada should offer a silver-only fund on several occasions. 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 number one, 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.