Silver is no doubt tiny on the grand commodities scale. But its attractiveness, spearheaded by a 1000%+ bull-to-date gain to its latest high, has spawned a wide range of products for investors to partake in. And one of the most unique and powerful is the SLV iShares Silver Trust ETF.
This ETF’s objective is quite simple, to mirror the price of silver (minus a small management fee of course). But while simple in its objective, two unique traits have allowed SLV to take the silver market by storm. First is SLV offers a bridge for stock-market capital to track the price movements of a high-flying commodity, which historically had only been an arena for the futures guys. And second is it uses this capital to buy the physical metal.
SLV is asset-backed by silver bullion. So not only is a share of SLV equivalent in value to an ounce of silver, it is backed by a physical ounce of silver that is sitting in a big vault somewhere.
The mechanics of this ETF are of course a little more involved given its asset-backed model. As opposed to other commodities ETFs/ETNs that simply track a price via rolling futures contracts, SLV needs to manage a physical inventory. And managing a physical inventory to balance day-to-day demand/supply differentials, while tracking a price, is tedious.
In order to track the price of its underlying asset, SLV’s demand/supply needs to be equalized on a daily basis. And in order to counteract differential buying and selling pressure, SLV actively buys or sells bullion. This daily equalization is of course successful per SLV’s rules, otherwise this ETF would decouple from the price of silver.
On the buy side, by nature this ETF faces situations when there are more buyers than sellers. When this happens for regular stocks, it translates into a price that keeps rising until a balance is found. And in SLV’s case this would be fine if its rise paced silver’s. Perfectly pacing a commodity’s price is impossible in a stock-trading environment though. And quite often SLV is in the situation where differential buying pressure would quickly lead to an upside decoupling from silver if it was let be.
SLV thus needs to counteract this upside decoupling by issuing new shares (in 50k-share blocks), and then using the proceeds of these shares to buy silver bullion. The new shares serve to effectively absorb the excess demand. And at the end of the day this keeps SLV from rising at a faster pace than silver.
On the sell side SLV can obviously see more sellers than buyers on any given day. But if differential selling pressure is not controlled, there would be a risk of decoupling from silver to the downside. In order to prevent this SLV has to buy back shares (again in blocks of 50k). And in order to raise the cash to buy back these shares, it needs to sell an equivalent amount of silver bullion. This process effectively absorbs an excess supply of SLV shares.
And provocatively this ETF’s market activity can have a material impact on silver’s fundamentals. Since SLV’s tracking mission shunts stock-market capital directly into (and out of) the physical metal, it affects the real-time supply and demand of the physical market, and thus silver’s price. And since this ETF is very transparent with its daily activity, a simple chart can show us just how relevant SLV can be to the silver market.
On the left axis is SLV’s net asset value. This value (in billions of dollars) is calculated by simply multiplying SLV’s daily holdings by the daily price of silver. And if SLV is indeed successful in its mission of tracking the price of silver, this red line should be a mirror image of what you’d see on a silver chart. Slaved to the right axis, in blue, are SLV’s holdings (in millions of ounces).
To get a sharper picture of the most recent years, this chart only goes back to 2008. But it wasn’t too long before this, in April 2006, when this ETF was born. And folks may recall its mixed reception at the time. While the majority of investors and silver bulls were excited for SLV’s launch, there was opposition from industrial consumers. Though their fears were righteous for the most part (supply coming off the market and thus driving up prices), there was no stopping investors’ craving for this exciting trading vehicle.