The Silver ETF: Flawed Design, Questionable Investment (SLV, GLD, IAU)

With all the hoopla about the introduction of the iShares Silver ETF (SLV), investors seem to have forgotten a big gaping flaw in the design of all the metal ETFs.

None of the metal ETFs own any income producing assets. Metal itself is dead, and therefore fund expenses -- 0.40% for (GLD) or (IAU), 0.50% for (SLV) -- are taken from the ETF's bullion holdings. Every day the amount of gold or silver backing an ETF share shrinks. As the silver ETF's Prospectus helpfully explains:

The trust sells silver to raise the funds needed for the payment of the sponsor’s fee [...] and all trust expenses or liabilities not assumed by the sponsor. The purchase price received as consideration for such sales is the trust’s sole source of funds to cover its liabilities.

For example, on Jan 03 2006, each share of streetTRACKS Gold Trust (GLD) held 99.552% of 0.1 troy ounces of gold. Today on April 27 2006, each share of GLD holds 99.433% of 0.1 troy ounces of gold. On GLD's inception date November 18th 2004, each share held 100.00% of its starting NAV. You can watch your GLD vanish on the official streetTRACKS website.

An commodities fund like DB Commodity Index Tracking Fund (DBC) or United States Oil Fund LP (USO) that uses futures does not have this problem because interest from the bonds deposited as margin for future contracts is used to pay fund expenses and offset losses due to contango.

A simple solution for NAV erosion is for the gold and silver ETFs to lend their bullion and collect "leasing" fees. The fees would be used to offset fund expenses and increase fund assets/pay dividends over time. Alternately each share of an ETF could consist of metal and a preferred share of a trust that invests in treasury bonds/mortgages/TIPS -- i.e. each share of GLD would consist of 0.1oz of Gold and a preferred share of par $10. Income earned by the trust in excess of fund expenses would be paid as dividends on the preferred shares. Whenever a creation transaction occurs, the preferred shares would be redeemed or issued as needed.

Many equity ETF's lend their securities to short sellers to generate fees from short interest. These earnings are used to offset fund expenses. The current precious metal ETF's policy of holding only physical bullion and having no source of income requires erosion of NAV to pay fund expenses. This makes metal ETFs questionable as a long term investment or store of value.

Related: All articles on the iShares Silver Trust ETF (SLV)

Comments

[Roger Nusbaum:]

The keepers of the metal based ETFs would probably say that leasing, lending or any other activity that might create the perception that every bar was not exactly accounted for would create a bigger problem than the erosion.

2006 Apr 28 01:54 PM

[bionerd2:]

First, the futures markets add another party that must perform correctly for your investment to be intact, namely the other party to the futures contract. The ETFs are designed to eliminate the possibility of this type of default. Second, I doubt whether short term bonds would cover typical contango, which theoretically includes not only storage costs but also interest costs. (Long term bonds might be more likely to serve in this regard, but this would add interest rate change risk to the purchase of what is supposed to be a pure metal play.)

2008 Jun 18 09:32 PM

[antifiat:]

The whole point of investing in PM's is that they protect your capital from erosion due to inflation. With negative real interest rates the return on bonds is likely to be less than the real rate of inflation.

2008 Jun 19 06:00 AM

[Mike Moloney:]

My name is Mike Moloney and I work for ETF Securities here in London, I just came across your article on the “Bullion Des" which I found interesting, I’m not sure how familiar you are with our list of product offerings but we provide a vast range of ETC’s including ETFS Silver and ETFS Physical gold along with other precious metal ETC’s.If you have any queries on any of our products or you want to get a greater insight to our business please contact me and I would be glad to inform you. michael.moloney@etfsec...

2008 Jun 20 10:38 AM

[Ultra Power...:]

The SLV and GLD ETF's are apparently another clever device created by greedy bankers to give people the false feeling of ownership of real money and value, which apparently is eroded by sales of the bullion to pay fund manager expenses... Just another expample of dilution and inflationary policies, but repackaged differently.

Bankers have always been very interested in seperating the general public from real money (gold/silver in their own possession), while programming them to believe that paper is money. With the latest "Mother of All Bailouts" happening to protect the rich real estate speculators and failed GSE equity stock-holders (not the little guys trying to prevent foreclosure of the only house they own and live in)...

The Federal Reserve Board Banksters have taken complete control of US monitary policy, although they are not truly a Federal governmental agency and there is not really any Reserve... It's just a Board of Greedy Bankers, in business, of, by, and for themselves. They apparently are allowed to get away with stealing from the productivity of American workers through a silent and insidious tax upon earnings and savings, that they do not have to get any kind of permission from our Representatives in Congress to decide upon. The inflation they create by printing "money" out of thin air with paper and ink at their own disgression destroys the value of exhisting dollars, wages, and savings, and affects us all in ways most Americans don't have a clue about and can not even conceive.

I can already hear those Printing Presses pumping at turbo-overdrive day and night printing (mainly the high denomination variety $100 Notes and perhaps $1000 Notes, which cost the same to manufacture as the $1.00 variety). Gold and Silver ETF's are much the same, in that they reduce by ignorance the demand for real Gold and Silver decentralized ownership, thus having downward pressure on the metals and mining companies... that is, until the fiat bubble bursts and Americans and other people around the world suddenly wake up in what resembles a bananna republic where hyper-inflation has kicked into overdrive, creating the emminent upcoming Gold and Silver Bullion, Coin, and Mining Company Equity Rush. By the time most people figure it out, their stocks and "dollars" will be accelerating downward to worthlessness, and it will be too late for them to exchange their paper "money" for the real deal.

I like the upward leverage of the long gold DGP, especially right now before the inflationary effects of The Mother of All Bailouts and simultaneous turbo-overdrive of the Treasury's Printing Presses printing out loads of high denomination Federal Reserve "Notes" (or just "notes", since it's not really federal and there's no reserve).

My suggestion to anyone that likes GLD or SLV ETF's at least switch to a leveraged ETF like DGB now, and ride the rocket upward for a while, but know when to "get out" and cash in your earnings, converting it to REAL MONEY (GOLD and SILVER) before the government authorized fiat system of silent insideous theft is discovered by the masses, who themselves will soon be seeking to get their own hands on some REAL MONEY, exchanging what's left of their Federal Reserve "Notes" they still possess for it, regardless of how worthless they have become. The real rate of inflation is already in hyper-devaluation mode, as any person living in the real world can feel as measured by the MISERY INDEX of real inflation (the official inflation numbers we are fed + the F's: Food and Fuel).

I suggest that while GOLD is currently at six month lows, but on an overall upward bullish uptrend... Ride DGP upward, then when you have doubled your investment in it, take half out and convert it into real GOLD (and keep riding it upward), or better yet, convert earnings to "Junk" SILVER COINS, as silver is tremendously undervalued at more than a 50-1 Silver/Gold ratio. When the Constitution of the USA once meant something, A "DOLLAR" was constutionally/legally one ounce of Silver or 1/20th an ounce of Gold (thus the $20 One Ounce Liberty). The awakening of the masses to the difference between FIAT currency (fake) and real money (Gold/Silver) is coming, and likely, sooner rather than later due to...

THE MOTHER OF ALL BAILOUTS (American Socialism at it's best)

Right now would also be a very good time to find/buy stock in A Junior MINING CO (they're extremely undervalued) that's found a MOTHER LODE of SILVER, COPPER or GOLD... Sit on the Mother Lode of Real Money, or even whatever you can afford to get NOW...

Then wait for the Coming Tsunami of Global Inflation that will soon trigger - THE GREATEST GOLD RUSH HISTORY HAS EVER SEEN.

2008 Jul 26 03:36 PM