On June 2, with the next-month silver futures contract around $37.30 per ounce, I blogged that “Silver Is Probably Overpriced“. It is now $34.75 on the futures market. One way that I believe is a good way to track whether silver has bottomed relates to a topic I discussed in that post:
The silver space is replete with allegations of market manipulation, and if some of them are correct, its price could indeed skyrocket soon. However, I am skeptical, because a major paper silver trading vehicle, the Sprott Physical Silver Trust (PSLV), trades at a 17.1% premium to its net asset value. Why anyone would pay that much of a premium for a fund that holds silver, even with a redemption policy into physical for very large holders, is beyond me.
Since then, the premium to the value of the silver held in trust at PSLV has shrunk to 13.05%. I do not believe this is yet near fair value, and thus I believe that this well-known vehicle for silver investment/speculation suggests that there is much more optimism that “needs” to come out of the retail silver market before a durable market bottom can be formed that would allow conservative investors to enter silver as a long-term buy and hold asset.
Here are some considerations. First, one has to own over $300,000 worth of PSLV in the same account to qualify to take possession of physical silver from the trust. My guess is that very few people or institutions own that much PSLV stock. Per the Prospectus, annual expenses may be 0.80% of assets. There are more cost-efficient ways to own a silver bar, and those ways allow immediate liquidity. Thus I treat PSLV as an investment product for the small investor. The premium to net asset value (NAV) thus is a reflection of retail investor excitement for silver.
Back in the days of high interest rates when I began investing, it was held that closed-end trusts such as PSLV, where one owns stock that owns assets (which may be common stocks, bonds or commodities) “should” sell at a discount to the value of their assets, and one common valuation measure was to multiply the annual expense ratio by 10 to derive a “proper” discount. That calculation would suggest that PSLV should trade not at a 13% premium but at an 8% discount to NAV. On the other hand, buying and selling physical silver is a bit cumbersome and entails meaningful bid-asked spreads, perhaps 5%. That could suggest that a premium of up to 5% above NAV is appropriate.
How are comparable silver vehicles valued? The popular iShares Silver Trust (SLV) currently trades at a 2.5% discount to NAV. Many silver aficionados mistrust SLV, doubting that its shares are fully or even partially backed by unencumbered physical silver. So perhaps that’s not an ideal comp. There is fortunately another 100% physical silver trust, like PSLV also a Canadian entity, though one with limited liquidity in the US markets. This is the one run by the Spicer family, which got the physical metal “ball” rolling decades ago with Central Fund of Canada, which (full disclosure) I own and which they followed with Central Gold Trust and then with Silver Bullion Trust. This trades on the Toronto Stock Exchange as well as a “Pink Sheets”-type stock OTC in the US.
Silver Bullion Trust closed yesterday at a 1.3% premium to NAV.
It therefore appears to me that the shrinking premium to NAV that the PSLV trust carries is indicative of a waning of speculative enthusiasm toward silver but that at 13%, it remains clearly excessive and therefore probably reflects over-enthusiasm. I have noted innumerable assertions in the blogosphere about “trapped silver longs” in the futures market. Supposedly there is a shortage of physical silver. However, you may click HERE to view Kitco’s presentation of silver demand and supply. Mine supplies of silver have been rising over the years and are scheduled to rise more in the several years ahead. So the only shortage comes from investors/speculators buying in. And we know how fickle that can be.
My sense therefore is that there are probably no “trapped” silver shorts anymore. (Of course that view could well be completely wrong.) There may in fact come to be a growing number of retail investors in silver who feel trapped, or perhaps just disappointed and bored. One way to look for capitulation of them, should over the weeks and months ahead silver trend downward from here or perhaps stay in a trading range but no longer be “exciting”, is therefore to follow PSLV’s premium to NAV. (The bullish scenario involves silver rising in price as the premium to NAV shrinks. Could happen.) You can track PSLV’s premium or discount to NAV on an up-to-the-minute basis through this LINK. If it gets below a 5% premium, I’ll get interested again. Should it drop to no premium, I’ll be very interested.
Please note that I am an owner of physical silver, both through direct ownership and through the stock market (thus there is a “paper” component to said ownership). I do suspect that one of these years, silver will bust through $100/ounce and perhaps go much higher, and that some of this potential appreciation may reflect real returns rather than simply tracking general price inflation. But to everything there is a season, and for what little it may be worth, my sense is that the season for commodities has come and gone for a while. And to the extent that silver starts trading as an industrial commodity rather than as “the poor man’s gold”, it can move with copper and oil as sharply to the downside as it has moved up from about $20/ounce when I wrote favorably about it on September 8, 2010 to around $50 not long ago.
As a hard asset with certain “real money” characteristics, silver is a fascinating asset. It may well be “underowned” by deeply mainstream money such as pension funds. But it attracts quite a varied crew of investors to it as well as short-sellers. It has always rewarded speculators investors who bought it “right”. But buy it “wrong” once and one is perhaps unlikely to ever buy it again. A “buy right” entry point may well await the patient watcher and waiter.