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Silver ETF Explained

Silver ETF : Did you know that you can invest in gold and silver as easily you trade in your favourite shares and mutual funds? This was made possible by the setting up of gold and silver Exchange-Traded Funds (ETF).

Institutional investors, such as pension funds, are constantly looking for ways to diversify their portfolio. The relative stability of precious metals prices offers them protection from the volatility of the equity markets. However, they were not permitted by law to have physical holdings of these metals. To enable these funds to invest in precious metals, ETFs were created.

How An Exchange Traded Fund Works

The way it works is like this. A financial institution buys a certain quantity of the commodity from the market and keeps it in its custody. It then issues common shares at a fixed conversion rate to the commodity. Investors can buy these shares through stock exchanges and get fractional ownership of this commodity.

Barclays Global Investor International Inc. set up the world's first silver ETF called iShares Silver Trust. They initially purchased and deposited 1.5 million ounces of silver with the custodian of the fund and issued one share per 10 ounces of silver. These shares started trading on the American Stock Exchange (the "AMEX") under the symbol "SLV" on 28 Apr 2006.

This fund buys and sells silver continuously depending on the demand for its shares. On the day of its launch, iShares Silver Trust bought 20 million ounces of silver from the market. Such has been its popularity with investors that the silver holdings of this fund went up to about 140 million ounces within a year. This makes Barclays holding larger than the 130 million tons accumulated by Warren Buffet's Berkeshire Hathaway in the late 1990s.

The Booming Times

How did it become so popular that it grew hundredfold within a year? The reasons are not hard to guess. Institutional investors appear to be bullish about the long term prospects for silver. And with hundreds of billions of dollars at their disposal, they can buy a million ounces at $13/oz without batting an eyelid.

The silver ETF has also provided an easy method for the retail investor to hold a position in silver. Before the advent of ETFs, the cost of storage of precious metals used to be a major concern for investors. This was particularly the case with silver due to its relatively low price. You could buy about half a ton of silver for $100,000 but where do you keep all that metal? Investing via the silver ETF has brought freedom from the hassles of storage and has correspondingly reduced the cost of ownership of silver.

For large industrial users, the silver ETF can potentially be used to get immediate delivery of silver. At present, they have to buy a futures contract on the Commodities Exchange (the "COMEX") and wait at the sellers option for delivery. Redeeming the shares is a much faster mechanism for getting delivery. The iShares Silver Trust redeems shares only in "baskets" of 500,000 ounces which is too large a quantity to be of interest to an industrial user. However the basket size may come down some day and when that happens, people will look at the ETF not just as an investment vehicle but also as a source of immediately available silver.

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