Eric Sprott Must Think Silver is Going Lower!

You’re probably confused by the post title, right?  After all, Sprott’s Physical Silver Trust ($PSLV – no positions) just announced a $ 200MM secondary offering.  Here’s the fun part – we can look at the actual data and draw some conclusions about what went down.

First, take a look at a snapshot of PSLV’s Net Asset Value page from last night (7/11/2012):

PSLV Net Asset Value, post close 7/11/2012

Then take a look at the same page from tonight (7/12/2012):

PSLV Net Asset Value, Post close 7/12/2012

I explained the methodology last time around, but we can use these numbers to back into the price per ounce that PSLV paid for their silver purchase today.   In fact, we can do more than that.

The first thing that should stick out to you is the difference between the last two lines in the second (7/12/2012) snapshot:  the difference between the total NAV of the Trust and the market value of the silver held by the Trust is an approximation of the cash that the Trust is holding.  As of tonight, it’s $ 59.7MM.   That’s a huge number.   It’s much bigger than normal: it was $ 8.5MM immediately preceding the secondary.     After the Trust’s January, 2011 secondary, the Trust held roughly $ 9MM in cash.  Sprott’s much larger Physical Gold Trust ($PHYS, no positions) currently holds about $ 22.7MM in cash – but as I noted, it’s a much larger fund with larger expenses as a result.  Of course, PSLV holders don’t want the Trust to be holding too much cash:  when the price of silver goes up, the cash portion of the Trust doesn’t.

So the point here is simple:  PSLV is holding much more cash than it normally holds and than we’d normally expect it to hold.  The obvious question is, WHY?  Well, take a look at the intraday chart of silver today (green line):

Can you see what happened?  The PSLV secondary offering priced a little before 9:30am.   Sprott’s bankers went out to buy silver for him, but the sellers were ready (yeah, guess what – they read the same press release everyone else did last night – they knew PSLV was coming in to buy silver, so they figured they’d stick it to him*) and tried to squeeze him.   They pulled their offers and the price started rising.   I’ve been in situations like this as a trader before, when you’re trying to buy something that’s ripping higher.   Normally, you end up on the phone screaming at your broker “WTF ARE YOU DOING YOU F*CKING MORON!!??  STOP RAMPING IT.  BACK OFF!”  I imagine Sprott had a “conversation” similar to this, and that he actually cancelled his order before it was complete!  Hence, the Trust is left with a larger than normal cash position because they didn’t finish executing their order!

Now, if Sprott actually cancelled the order (and it certainly seems like he did from looking at the data), that must mean he thinks that the price of silver is going lower (in the short term) – hence the post title!

This actually poses a problem for PSLV shareholders, though:  there’s another number that we can calculate from the data, which is “ounces of silver per share outstanding of PSLV.”  It’s not a hard calculation – it’s exactly what it sounds like:  ounces of silver divided by shares outstanding.  You can think of this as how much silver is represented by one PSLV share.   Before the secondary, as of 7/11/2012, this number stood at .3920.  After the secondary, since the Trust issued shares but didn’t buy “enough” silver, this number declined to .3738.   In other words, the secondary thus far was actually dilutive in terms of the silver represented by each share:  each share now corresponds to less silver than it did previously.   The Trust just essentially reduced its per share silver exposure and increased its per share cash exposure – decreased “bang for the buck” in terms of benefit if the price of silver rises.

Sprott will try to remedy this, of course, by completing the purchase of silver at advantageous prices (he has a small cushion, because the secondary was done at a small premium to net asset value), but he is exposed to execution risk on the balance of the order.

Getting back to the before and after numbers, we can approximate the price that Sprott paid for the 5,234,113 ounces of silver that he did buy today.  Again, the process was outlined in the previous post on this subject (linked both above, and below), but the methodology is simple:

we take the amount of cash that the trust raised (number of units sold x net price to trust after underwriting commissions and fees),  then we figure out how much cash was spent (by taking the cash raised minus the increase in the Trust’s cash position), and then we divide the cash spent by the number of ounces purchased.   I get $26.84 per ounce, which makes perfect sense given the explanation I have provided thus far and silver’s price action today, and gives further credence to my theory that Sprott canceled the order as a result of the execution quality.

I will continue to watch the PSLV NAV data in the coming days for updates.  If you’re thinking ahead, you’ll notice that this subject brings up a pretty interesting Green Shoe quandary that closed end physical metals funds face, but I’ll save that post topic for another day…

related: Paper and Physical Silver Prices are Not Decoupling Yet


* the gut silverbug reaction is “See, Sprott went out to buy silver and his order moved the price!”   I think that’s clearly incorrect, as the entire market knows that Sprott was coming in to buy silver – if his order was going to move the price due to unavailability of silver, it would have moved higher last night on the announcement of the secondary as traders pre-positioned themselves ahead of any impact caused by the imminent PSLV order.   It looks like what happened instead is that the traders (not necessarily his own bankers – the rest of the market) were waiting for the order and tried to stick it to Sprott on the execution.  PSLV’s bankers are Morgan Stanley and RBC, and their activity this morning would be a dead giveaway that the PSLV order was being executed.   Once the offering is priced, the Trust ends up in this tough position, as I described above (they need to buy silver with the fixed proceeds, but also don’t want to overpay for it and are at the mercy of the market), which is another disadvantage of closed end funds compared to ETFs  – the ETFs just require Authorized Participants to bring them a fixed amount of silver in exchange for newly created shares, and the ETF bears no price execution risk.

note for accuracy:  I have used the term “shares” throughout this post, but PSLV actually has “units” outstanding – in case anyone wants to be a semantic stickler

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