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New Demand From a Silver ETF?

Barclays Global Investors filed last June with the SEC to establish a silver exchange traded fund, or ETF. Barclays anticipated few roadblocks, since it already manages a gold ETF, iShares Comex Gold Trust. However, they are still waiting for approval seven months later. Last week, the SEC belatedly agreed that the ETF could list on the stock exchange, and initiated a three week public comment period.

Precious metal ETFs sell shares which represent bullion held in vaults. Many investors are intimidated by the thought of buying and storing bullion, but are comfortable buying stocks. Exchange traded funds are designed to track the price of the metal, and allow the consumer to profit from price appreciation. Barclays estimates that initial demand would require the purchase of 130 million ounces of silver. Since there is approximately 124.8 million ounces stored on the COMEX, and much of that silver is not for sale, Barclays would have to obtain the remainder from other sources.

The Silver Users Association (SUA) strongly opposes any silver ETF. The SUA is a unique organization, as silver is the only commodity with a users group. The group asserts that the silver supply is too tight to accommodate an ETF. They claim that Barclays' fund iShares Silver Trust would cause price spikes, and force businesses which use silver to pass on the costs to the consumer. If consumer demand drops, these companies may be forced to lay off employees.

The SUA has several large holes in their logic. First, they totally ignore the impact on the silver mining industry. After a long sector bear market, many mines are still not producing. An increase in demand would induce companies to hire miners, geologists, and support staff. Many of these jobs would pay well, and be located in the silver-rich American West, not abroad. New employment would revitalize struggling mining towns, and new businesses would spring up to take advantage of this money infusion.

Second, silver is a very small part of the cost of most consumer goods. There is so little silver in electronic goods such as cell phones that few people bother to recycle it. Even if silver doubled in price, it would only add a few cents to the cost of each item. This would hardly be enough to crimp demand.

The SUA's mission is to keep silver prices low for its members, like Tiffany & Co. They argue simultaneously that silver must stay at this low price to avoid layoffs, then admit that the price isn't high enough to ensure an adequate supply! If you look at an inflation adjusted chart of the silver price at http://goldinfo.net/silver600.html you will see that the metal is very cheap by historical standards. Just to equal the spike in 1980, silver would have to reach almost $130 per ounce in today's dollars. Ironically, price increases in the 1970s spurred consumer demand instead of stifling it.

Critics at http://www.lemetropolecafe.com are concerned that the silver ETF could eventually be used to suppress the silver price. One of the gold ETFs, streetTRACKS® Gold Shares, is notorious for buying and selling large blocks of gold without a clear link to trading action (see http://www.discountsilverclub.com/news_12-18-04.html for more details). Although Barclay's silver would be allocated, it could later be leased into the market, dampening the price. As iShares Silver Trust behaves like a stock, manipulators could sell more silver than exists in storage. Silver stocks currently suffer from these naked shorts, and COMEX silver has a huge short position which dwarfs warehouse stocks and yearly mine supply.

Whether or not you believe a silver ETF would benefit the silver market, one fact is clear. If there is a severe shortage of available silver, Barclays' ETF will expose that weakness, and we will see a spike in the silver price. This would help junior silver companies who would be able to start mining, and cause their stocks to appreciate as well. Even if we see a sharp correction in the future, I believe the supply and demand fundamentals will support the bull market trend in place since 2001.

Jennifer Barry