On SLV's 10-for-1 Split: It's All About Liquidity

Some of us have speculated before about the reason Barclays split the iShares Silver ETF (SLV) 10:1 (and some other ETFs by varying amounts) on July 21. Personally, I thought it had to do with added liquidity, an attempt to align the ETF’s price with the underlying (silver bullion) itself, attracting smaller investors, and/or a desire to move toward real-time NAV calculations like big-brother GLD.

Well, I was wrong. What it had to do with was the reduction of the basket size, or the minimum ounces of silver that the Authorized Participant needs to deliver to/from the iShares Trust in exchange for receiving or redeeming a corresponding number of shares.

Before, an Authorized Participant who wished to profit from closing any gaps between the price of SLV and the price of spot silver would have to either (1) accumulate 50,000 shares before redeeming them for 500,000 oz. silver or (2) distribute 50,000 shares after delivering 500,000 oz. silver. This may not seem like a lot based on SLV’s average daily trading volume of over 500,000 (pre-split) shares per day, but considering that the price of SLV rarely meanders very far from par, a 50,000 share position may actually present some holding risk to some Authorized Participants. At a minimum, it might not be a very attractive proposition.

In fact, SLV appeared on the Reg SHO Threshold list for several days earlier this year, most likely due to Authorized Participants selling shares in advance of acquiring a basket. This is known as short selling and since ETF shares can be particularly difficult to borrow, it can easily result in fails to deliver (which some call “naked” short selling). Doing so allows the Authorized Participants to accumulate the 500,000 oz. of silver incrementally and therefore take advantage of even relatively small price gaps. Given all the tinfoil hat speculation in the gold and silver camp about the existence of metal backing, however, it’s a particularly undesirable thing for SLV (or GLD) to appear on a list of securities with delivery failures (”naked” shorts).

With the recent split, an Authorized Participant need only deliver 50,000 ounces of silver in each basket. That is obviously a much easier task and means that the spread, if any, between the price of SLV and the spot price of silver should be tighter than ever. When making your own comparisons, don’t forget that the net asset value per SLV share will decline over time as a result of the annual 0.5% administrative fee. For example, each SLV share currently represents not one ounce of silver but rather 0.9885 oz.

But judging by the large additions of silver to SLV in the past few days — a total of 9.2 million ounces, or 286 tonnes, since last Friday — the 10:1 split has had another effect. Namely, it may have actually increased the pace at which silver is being added to the Trust. Think of it like the difference between water and sand flowing through a sieve. Since water particles are much smaller than sand particles, they travel through the openings faster. This is true even when the openings are much larger than the average sand particle. There is usually some sifting of sand required to keep the material moving at a decent pace.

With SLV baskets more like water now than sand, we may see the premier silver ETF go on an absolute gobbling spree in the months ahead. This on top of SLV being possibly one of the most strongly held investment vehicles out there with virtually no decline in its holdings after a 40%+ price drop. The future of SLV and silver could be quite interesting!

Disclosure: Long SLV, long GLD options.

Comments

[dieuwer:]

I would expect SLV redemption to actually go up if the silver futures price represented by the symbol "SLV" is well below the physical silver price.
Since this has not (yet) happened, I wonder if the trust actually holds and real silver. Perhaps it will turn out a bogus investment and it will be "ENRON" all over again.

2008 Aug 21 08:42 AM

[HarMegiddo:]

Comparing SLV trust to Enron???? Get a life buddy!!

2008 Aug 21 08:57 AM

[vince v:]

"SLV appeared on the Reg SHO Threshold list for several days"

Will someone please educate me on the meaning and significance of this phrase. Thx in advance for your assistance.

2008 Aug 22 11:12 AM

[sieraromero:]

I am a bit confused. Will this 10/1 split in SLV make it easier or harder to naked short the silver positions of the big boys? anybody with any thoughts on that?

2008 Aug 22 12:32 PM

[NC Trader:]

vince- the Threshold list is maintained by the SEC. It shows any stocks that have consistent "fails to deliver" on trade settlement day. IE- I short sell the stock, on day T+ 3 when I am supposed to deliver the shares to the buyer I can't. I think is a good indicator of naked short selling, although I am sure some will disagree.

2008 Aug 22 02:37 PM

[secmaven:]

Excellent explanation of the split. Tom, you should send this article to Ted Butler so he knows there is another very astute silver analyst out there.

2008 Aug 22 02:58 PM

[Tom Szabo:]

Actually, the threshold list is maintained by each exchange as they are self-regulated organizations (SRO) .

The splitting of SLV shares makes it unnecessary for naked shorting of shares in order to build up a basket size for redemption. Think of it this way: before, 50,000 shares representing 500,000 oz. of silver were issued in each batch or basket. It could take days for a single Authorized Participant (AP) to sell these shares, especially since there are multiple APs out there not to mention funds that try to lead them. That put them at risk of not only earning the arbitrage profit but actually taking a loss on the trade. So what the APs did was sell shares ahead of time which allowed them to lock in a price and acquire an equivalent amount of silver with no further hedging required, and then once they had sold 50,000 shares they could deliver the silver to the Trust and the shares to the buyers. Of course, if this was not done in T+3 and the shares were not borrowed (it can be difficult if not impossible to borrow ETF shares), then the AP had a fail to delivery. If this persisted for more than a few days, the failed trades would show up on the Reg SHO report. Note the AP is not actually naked short because it has been incrementally acquiring silver as it sells the shares. In any case, reduction of the basket size from 500,000 oz. to 50,000 oz. allows the AP to avoid this altogether because it can transact in smaller quantities and more often. One other thing that I did not mention in the article but is important to consider is that the basket size reduction is probably reflective of a re-assessment by Barclays about the liquidity of the physical silver market itself. In other words, whatever liquidity that the physical silver market had in their view when they launched SLV in early 2006, that liquidity has gotten more viscous.

Regarding Ted Butler, trust me he knows who I am as he or his associates are usually among the first to read the comments on my website.

2008 Aug 22 04:19 PM

[davemcc3300:]

I always look for Tom Szabo's publications: he really knows his precious metals, speaks openly (something potential PM investors really respect), and has no apparent "agenda".

When "secmaven" approves of what he says, I consider it a valid piece worth re-reading. Thanks to both of you.

Dave

2008 Aug 23 04:51 PM

[Todd47:]

Reduction of silver per share of SLV.
Big desperate finacial players short a major amount (40%) of the SLV counting on market manipulation for big gain, manipulation fails, short term silver moves from $10 to $11. SLV figures $1 gain on every ounce shorted but the finacial institution(s) go bankrupt leaving each share short 40% of its silver and worth .59 oz.of silver.
Could this happen? I own SLV/GLD

2008 Nov 30 10:42 PM