Silver investors often make noise of the disconnect in pricing between “paper” and “physical” silver. Many believe that the disparity is a sign of market manipulation. Why should physical silver – coins, bullion bars, or scrap silver – trade at a premium to silver on a futures exchange?
In all reality, some small spread between paper and physical silver is tolerable, if not expected. Physical silver is costlier to store, more expensive to ship, and generally broken into smaller units to be sold to the public. Add in the cost of overhead for a dealer and you have a recipe for premiums.
Premiums are eroding
One of the best ways to measure a premium is to compare the redeemable Sprott Physical Silver Trust ETV(NYSEMKT:PSLV) to something like the iShares Silver Trust (ETF) (NYSEARCA:SLV). Sprott’s product allows any unit holder that meets a minimum investment to take delivery of physical silver at any time. Blackrock’s iShares fund opens redemption only to authorized participants.
The difference allowed Sprott Physical Silver Trust to trade at a substantial premium to other silver ETFs, and the spot price of silver. If silver in a coin shop costs 5-20% more than spot, why shouldn’t Sprott’s redeemable units?
For much of the product’s history, Sprott Physical Silver Trust ETV(NYSEMKT:PSLV)’s fund maintained a huge premium to silver. Premiums to per-unit net asset value peaked in January 2012 at 34.22%, but in recent days the fund has, at times, traded at a discount to spot silver prices.
Yes, a fund backed by physical silver, which could be claimed by shareholders at any time, traded at a discount to its net asset value.
What a falling premium tells us
There are several takeaways from a shrinking premium, almost all of which discredit the long thesis from silver bugs and metal investors. Here’s what a nonexistent premium reveals:
Physical premiums should be gone – Premiums at brick and mortar stores as well as online dealers have exploded in recent days. Some interpret this as a clear sign of a shortage in a manipulated market. Sprott’s fund proves that wholesale premiums are nonexistent. Higher prices in dealer inventory are more likely the result of a higher cost basis for the largest dealers. No silver brokers want to sell silver acquired at $28 or $30 per ounce for $21 per ounce.
Investors want out – Closed-end funds with redemption options rarely trade at a discount to NAV. In the worst case, large investors snap up discounted shares, swap units for the underlying silver, then sell the silver at current market prices to arbitrage the disparity in prices. If physical silver is really worth a premium to spot, redeemable units should not trade at any noticeable discount to NAV.
If you want to be long silver go with this stock
Taxation can hit investors hard when it comes to physical medals. iShares Silver Trust (ETF) (NYSEARCA:SLV)’s fund leaves investors with a collectables tax rate. Sprott’s fund allows for lower, long-term capital gains taxes if investors hold for longer than one year.
The best way to play silver, should you choose to do so, is to play silver with a business model on top. Silver Wheaton Corp. (USA) (NYSE:SLW) is one of the best silver plays in the space because it is an asset-light, silver and gold streaming company that is primarily a lender but also exposed to silver and gold prices. In exchange for up-front financing, Silver Wheaton Corp. (USA) (NYSE:SLW) has the right to purchase silver and gold at below-market rates from its customers.
