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

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Includes: GLD, SLV
by: Tom Szabo

Some of us have speculated before about the reason Barclays split the iShares Silver ETF (NYSEARCA: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.