Posts Tagged ‘ETF’

How should you go about investing in silver?

Friday, July 10th, 2009

After having read our series of articles on silver, you may wonder how you should go about investing in silver. Knowing about the potential for silver prices to sky-rocket is one thing. Benefiting from it is another. Today, we will go into that.

First, as you may already have known by now, when we used the word “silver,” we mean physical silver bullion. Financial assets disguised as silver (e.g. silver ETF, silver certificate, etc), at the end of the day, are just paper assets- they are not the real thing. This is especially true for silver ETFs. For example, in the SEC filings for the iShares Silver Trust, it has clauses that say something like “the liquidity of the iShares may decline and price of the price of the iShares may fluctuate independently of the price of silver and may fall” and the “iShares are intended to constitute a simple and cost-effective means of making an investment similar to an investment in silver.” Silver paper assets are great for trading silver, but you may not want them as long-term investments.

Next, if you are very sure that silver prices will roar mightily in the future, should you pour all your life savings acquiring it?

To answer this question you have to understand that investing in silver falls under the Black Swan investment category. For those who haven’t already, we urge that you read Failure to understand Black Swan leads to fallacious thinking first. We encounter frequent and stubborn misunderstanding of the concepts of Black Swan. As we wrote in that article,

As we talk to more and more people, we encounter a very frequent lack of understanding of Black Swans (for those who wants to learn more about Black Swans in detail, we recommend this book: The Black Swan: The Impact of the Highly Improbable by Nassim Nicholas Taleb). As a result, many people have this erroneous belief that contrarians are predictors of gloom and doom. The more entrenched this lack of understanding (of Black Swans) is, the deeper the fallacy one will fall into. This lack of understanding will degrade the quality of one?s thinking, which can translate to severe financial loss when investing.

Today, we will again attack the stubborn entrenchment of this conception black hole.

Many people have heard of and read Nassim Nicholas Taleb’s book, The Black Swan: The Impact of the Highly Improbable. But not many really understand it properly. It took us a few re-readings of Taleb’s winding meandering prose to fully grasp the concept of Black Swans. If you have not read Failure to understand Black Swan leads to fallacious thinking, please read that first…

… now that you have read that article, you should be able to appreciate this fact: when we talk about the potential of silver prices to explode, we are not making a ‘prediction’ of the future. As we wrote in that article, a parachutist packing a backup parachute is not making the ‘prediction’ that his primary parachute will fail. The backup parachute is there to ensure his survival should his primary parachute fail, which is unlikely based on statistical probability. In the same vein, based on statistical probability, it is improbable that the silver fuses (that we wrote before) will light up because it had not happened before. But should the fuses light up, you can be sure that the price impact will be massive.

Therefore, to profit from Black Swan investing, you have to implement an asymmetric pay-off strategy. This idea is very similar to the one that we wrote in the guide, How to profit from a stock market crash?. As we wrote in this article in that guide,

The basic idea behind the asymmetric payoff strategy is simple. First, you structure your bet in the market such that if you lose the bet, your loss is very tiny, but if you win, your gain is very massive. Next, you bet that the market will crash within a specific period of time. If you lose that bet, place another bet for the next period of time. You do this repeatedly until the day of the Black Swan event when your profit overwhelmingly overshadows your accumulated small losses.

Obviously, the disadvantage of this strategy is that it requires fortitude to absorb small losses indefinitely while waiting for a highly rewarding final vindication in the end.

In the same vein, investing in silver means accumulating it slowly, bit by bit and patiently waiting for the silver fuse day. Because you are investing one tiny bit at a time, it should not have any material financial impact on your day-to-day life. In other words, you are investing with your ‘loose change.’

Maybe the day of silver fuse will never come. In that case, the most you will lose are your ‘loose change.’ But should the day of silver fuse arrives, your ‘loose change’ is going to be worth many times over, maybe even a fortune.

Remember, do not bet a large chunk of your life savings into the silver fuse story.

Possible fuses that can ignite silver prices: ETFs

Wednesday, July 1st, 2009

Today, we will talk about another long fuse that can propel the price of silver further-the rise of ETFs. In fact this applies to precious metals in general.

A precious metal ETF is basically a financial instrument that trades on the stock exchange and is designed to track the price of the underlying precious metal. As many funds, institutions, money managers, insurance companies are forbidden to own physical commodities, the only way for them to gain an exposure to commodities is via ETFs. Some experts believe that this is the primary purposes of ETFs.

Precious metal ETFS have enjoyed tremendous growth over the years. As this article reported,

Bullion held in depositories on behalf of gold exchange-traded funds investors is at record levels . . .  and, in recent days, has been growing by leaps and bounds.  Worldwide total gold ETF holdings now exceed 1325 tons (42.6 million ounces).

To put this number in perspective, ETFs now hold more gold than the Swiss central bank. Strikingly, gold held by ETFs now account for more than 40 percent of identifiable gold investment worldwide.

A very big question to ask is this: how much of the ETFs are backed by the physical precious metals? As David Morgan of said,

… that the “daisy chain” involved in SLV [stock code for the silver ETF] makes it complex and convoluted because, as stated above, the SLV investor owns the iShares [an ETF] (not silver–silver can never be redeemed). The shares are issued by the Trust (Bank of New York), which hires a Custodian, which can have any number of Sub-Custodians, Agents or Depositories, where the silver is purportedly held. Compare this “daisy chain” with the true silver owner, who owns and controls his own silver.

Let’s say there’s not enough silver to back the silver ETFs. Then the situation will be very much like what we mentioned in the previous article, Possible fuses that can ignite silver prices: unbacked silver certificates.

On the other hand, if the ETFs are 100 percent backed, then such explosive growth in the ETFs will consume a lot of precious metals for investment purposes. Assuming that as price inflation rages over the coming years, precious metals investments will become more and more mainstream. This will result in more and more funds and institutions entering the precious metals ETF bandwagon. The question is, how much of these ETFs will be fully backed?