Editorial: Market awaits SEC’s decision on Barclays’ proposed silver ETF

Precious metals investors smiled in early March as spot silver broke through the longstanding US$10-per-oz. barrier to post solid, new 19-year highs.

Purchases by investors and speculators have been important drivers in the price of silver and other precious metals of late, with an especially strong pick-up in silver prices in the fourth quarter of 2005 from funds on the COMEX, TOCOM and the over-the-counter market.

Since 2004, silver has actually outperformed gold, and, among the major metals, has only been beaten by zinc and copper.

Yet, for large investors, the silver market remains a problematic one, owing to its tiny size by global standards.

The Silver Institute’s official market watcher, GFMS, predicts that silver demand for 2005 will amount to just 878 million ounces, divided between industrial (44%), photography (22%), plus jewelry and coins.

Supplying that demand was silver taken from mines (73%), scrap (20%) and sales of government stockpiles (7%). For mine production, which is on a slight multi-year uptrend, primary silver production accounted for only about 30% of the total, with the rest coming as a byproduct of gold, copper, lead and zinc production.

While most large funds may be avoiding the silver market, retail interest for silver bullion is also still very limited, especially outside the U.S. Why? Because physical silver bullion is expensive for the average retail investor to store, insure and trade.

However, this may be about to change with the introduction of the iShares Silver Trust, an exchange-traded fund (ETF) being sponsored by the San Francisco office of Barclays Global Investors International, and with the Bank of New York as trustee and the London branch of JP Morgan Chase Bank as custodian.

Barclays’ aim with its silver ETF is simple: to disburse these silver acquisition and storage costs over all the trust’s shareholders, creating a cost-effective way for retail investors to load up on silver bullion.

Thus, the silver iShares would presumably track the spot silver price quite closely, with the ETF’s net asset value being determined at the end of each business day using the London Fix.

The sponsor’s fee (0.5% annually of the trust’s net asset value) plus other general and administrative costs would be paid for by periodically selling silver from the hoard.

Barclays is proposing to kick off the trust with just 1.5 million ounces of silver representing 150,000 trust shares. The company intends to issue shares on a continuous basis, issuing and redeeming them in blocks of 50,000, which would be listed and traded on the American Stock Exchange using the ticker “SLV.”

Owners of the silver iShares would have no voting rights, but also have no significant disclosure obligations, unlike typical commodities futures traders.

The ETF’s initial market makers — who will have a powerful influence — will be the securities arms of Barclays, Citigroup and UBS.

Unfortunately for one of the main targets of the new product — U.S. retail investors — any profits they make on the silver trust will be taxed at the maximum 28% rate used for “collectibles,” rather than the current 15% rate used for most other long-term capital gains.

The silver owned by the trust will be stored in England, though other locations may be added in the future. Importantly, if the ETF grows rapidly, it becomes less clear where the sponsor will buy additional silver bullion, since global stockpiles are relatively scant. Indeed, there was no mention in Barclays’ silver ETF prospectus that it had any side deals to purchase silver stockpiles such as Berkshire Hathaway’s, which is rumoured to exceed 100 million ounces.

Barclays submitted its silver ETF proposal to the U.S. Security and Exchange Commission last summer, and it has been wending its way through the system ever since.

Early 2006 saw the SEC open up a three-week period for public comments. While most were enthusiastic in their support for the proposed ETF, or neutral, one notable exception was the Silver Users Association, whose members process 80% of all the silver used in the United States.

The SUA argued narrowly that the ETF would remove so much physical silver from the relatively tiny spot market that it would drive up silver prices. This would add to its members’ costs and ultimately lead to job losses among SUA members.

There is still much conflicting opinion among silver gurus as to whether Barclays’ silver ETF will be approved in the end, given that the silver spot market is so small and illiquid, and thus open to price manipulation.

The SEC might reject it to avoid creating significant distortion in the silver market. On the other hand, the SEC already approved a U.S.-traded gold ETF and the paperwork is very similar.

The SEC’s decision should come within the next six months, and whatever it is, it will impact the silver market for years to come.