On Misinterpreting PSLV’s Premium

OK, I can’t take it anymore.  Repeat after me:  PSLV’s 20% premium to NAV is NOT an indication of supply shortages in the silver market.  PSLV’s 20% premium is NOT an indication of the true cost of “physical” silver. Seriously, folks,  use your heads.  PSLV is a closed end fund without any means to arbitrage price discrepancies.  That’s it – that’s pretty much all you need to know.  There’s no way for traders to create more shares by delivering silver bullion to the trust (like SLV’s creation process), and there’s no borrow available for traders to short PSLV when it gets away from its Net Asset Value.

Thus, PSLV’s premium is perhaps an indication of a small segment of the market’s IMPRESSION of shortages in the silver market, which is something else entirely.  What do I mean?  Let me explain:  there is a very small group (relative to “The Market”) of people whose actions determine the price of PSLV: the buyers of PSLV and the sellers of PSLV (which is only those who are already long PSLV – short sellers cannot express their opinions, due to lack of borrow).  “The Market” cannot determine the price of PSLV, because the market can only impact it in one direction (by buying).   This may sound like a strange or nit-picky distinction to make, but it’s essential.  You can’t draw conclusions like “the market is worried about silver, that’s why PSLV has a 20% premium,” because it’s not true:  The Market can’t do anything about the overpricing! (again, there’s no mechanism to correct the overpricing!).

A common response: “Hey Kid Dynamite, you don’t know what you’re talking about. SLV is a fraud. If there was nothing wrong with SLV, then PSLV wouldn’t trade at a 20% premium to its NAV while SLV trades right at NAV.  If there was nothing wrong, then traders would short PSLV and buy SLV and collapse the price difference. But they don’t, therefore SLV is a fraud.

Yeah – that’s exactly my point – traders would, if they could, but they can’t so they don’t. Using false deductive reasoning will just lead you to the wrong conclusions.

Another response: “Hey Kid Dynamite – the last time you wrote about how silly buying PSLV at a premium was, it was trading at an 11% premium.  Now it’s 20% – so the premium can go up too!

Yes – of course the premium can go up.  If you want an instrument which is a measure of the fear and mania of retail investors in the silver market, PSLV’s premium measures exactly that!  It’s a way to bet on the mania.  Of course, you take the risk that Sprott will do a secondary offering and crush that premium, which is exactly what happened with his Physical Gold Trust, PHYS.  You also take the risk that investors will wise up and realize that they are paying $120 for $100 worth of silver, and decide to trade more effectively and efficiently.    If you want an instrument that exposes you to the price of silver without adding the extra risk that you might see a decline in  the mania, fear, and supply/demand dynamics which result in PSLV’s premium, then you can buy SLV without the premium.  I think the price of the underlying metal is hard enough to handicap – do you really want to handicap market mania and retail investor ignorance too?  That’s what you’re doing when you buy PSLV at a big premium – a Greater Fool Trade – you’re betting that there will be greater fools who will be willing to pay more of a premium when you want to sell.

There is an instrument, of course, which you will be able to use as an indicator of real stress in the silver market:  SLV.  SLV is liquid, easily arb-able (via the creation mechanism), and can also be shorted.  When demand for SLV pushes the price above its Net Asset Value, arbs stand ready to short shares of SLV, buy physical silver bullion, and deliver the bullion to the Trust in exchange for newly issued shares of SLV (that’s called CREATION).

Now, IF there’s no silver available, the arbs won’t be able to do this – they won’t be able to keep SLV’s price in check, tightly related to its NAV, and SLV will trade at a premium.  Because SLV is a robust, efficient, arb-able instrument (by which I mean that price discrepancies can be corrected by Mr. Market) , any premium or discount it trades at IS an important market signal.

Let’s look again at how that’s different from PSLV.   If Stevie Silver Miner came up with 100 billion ounces of silver tomorrow, there’s not a single thing he could do about the fact that PSLV is trading at a 20% premium to its net asset value.  On the other hand, if SLV was trading at a premium due to shortages of silver supply, Stevie Silver could take his newly found abundance of silver, deliver it to the SLV Trust, create new shares, and sell them at a premium to the amount of silver he just delivered.  Free money.  Oh, by the way, the SLV Trust added 4mm ounces of silver last week, as a result of the creation mechanism functioning as described.

As usual, I will indulge all intelligent questions, but will not get into a “SLV doesn’t have the silver,” or “they are lying” debate.  If you don’t believe that SLV has the silver, and think that it magically trades right at its NAV because one of  the most liquid silver instruments in the world is a gigantic scam and has managed to fool billions of dollars of capital that’s much smarter than yourself and your fellow internet message board warriors, and that the SLV trust is just making up data about how much silver is being added to their vaults on a daily basis, and that their auditor is in on the scam,  well, good luck – I know you won’t be convinced.   In addition, there are lots of people who are worried about “disclaimers” in the SLV prospectus.  If you’re buying PSLV at a 20% premium, you had better damn well read its prospectus, because they have the same disclaimers (see Appendix 2).

Final thought: SLV trades roughly $900MM in notional on an average day.  PSLV trades less than $20MM.  Which do YOU think is a better indicator of the silver market?

I am long SLV and bullish on the price of silver.  It scares me when I hear blatantly incorrect trade theses being voiced by those on the same side of the trade as me.  Think about that – a weird sort of anti-confirmation bias!


Appendix 1:   More on SLV and faulty deductive reasoning:  “Hey Kid Dynamite, we know SLV is a fraud because they claim that the amount of silver in their vaults increases by huge amounts (4mm ounces last week), and Sprott can’t get silver, therefore SLV can’t get the silver and they are lying and they don’t have the silver.”  Sprott can get the silver – he just doesn’t want to.  Having his competing instrument (PSLV)  trade at a 20% premium has caused all sorts of uninformed players to draw false conclusions and want silver, and his PSLV, even more!  It’s amazing – the higher premium makes people want it more, like a self-reinforcing feedback loop.  If Sprott does a secondary, satisfies demand for PSLV, and crushes the premium to zero (Oh, by the way, he did this with his gold fund, PHYS last year – it used to trade at a 20% premium, and people used to say the same thing about PHYS vs GLD), it would eliminate the hype and fear on the part of the PSLV buyers, and, insanely, make PSLV “less desirable” in some sense.

What’s the easiest way for Sprott to get the silver?  He could buy SLV shares and redeem them.  Of course, if he did that, we’d see the movement from silver in the SLV trust align with the PSLV secondary offering, and it would offer proof that PSLV was a redundant product.  So Sprott’s in a pickle there, isn’t he?  He charges fees of  a % of assets in the Trust, but if he adds metal to the trust he can kill the illusion that has been created!  And before you say “Sprott knows that SLV doesn’t have the silver,” I submit to you his own report on  silver demand, where he cites SLV’s large inventory as the largest component of visible silver investment demand.

But the easiest way for Sprott to get more silver would be for him to open up his fund and let The Market bring the silver to him:  allow market participants to receive newly created PSLV shares at Net Asset Value in exchange for delivering silver bullion to Sprott’s Trust.  He’d get all he could handle in short order, and the PSLV premium would get whacked. Traders would deliver silver to Sprott at NAV, get new shares, and sell them at a 20% premium to NAV, until that premium declined.  They’d probably even get the silver from SLV – it would be a win-win for Mr. Sprott: he could gather assets at SLV’s expense.

Additional data point:  I’ve had a manager at a prominent global mint contact me and say “I’m thinking about calling Eric Sprott and offering him silver bullion – he keeps saying he can’t get it, but we can get him plenty.”

Appendix 2: Disclaimers.  There are lots of people who learn everything they know about silver, ETFs, etcetera from reading group-think internet forums (CONFIRMATION BIAS, people, CONFIRMATION BIAS!), and watching asinine Youtube videos about how SLV is a conspiracy beacuse its prospectus contains disclaimers.  For those of you who want to order silver coins and bullion and bury them in the yard, good luck – but for those of you who write off SLV and buy PSLV instead, I’m fairly certain you haven’t read PSLV’s prospectus, which contains the exact same variety of disclaimers.  Again, I am not especially concerned with these disclaimers, but if you’re running from SLV because of them, well, you’re a victim of misinformation.  Here are a few of the disclaimers, straight from PSLV’s prospectus:

– The Trust will not insure its assets and there may not be adequate sources of recovery if its silver is lost, damaged, stolen or destroyed

-If there is a loss, damage or destruction of the Trust’s physical silver bullion in the custody of the Mint and the Trust does not give timely notice, all claims against the Mint will be deemed waived

-RBC Dexia, the Mint, the Trustee and other service providers engaged by the Trust may not carry adequate insurance to cover claims against them by the Trust.

-In the event the Trust’s physical silver bullion is lost, damaged, stolen or destroyed, recovery may be limited to the market value of the silver at the time the loss is discovered

-Under Canadian law, the Trust and unitholders may have limited recourse against the Mint.

-The Trust may terminate and liquidate at a time that is disadvantageous to unitholders

-The Trust may suspend redemptions, which may affect the trading price of the units

-Unitholders will not have the protections associated with ownership of shares in an investment company registered under the Investment Company Act or the protections afforded by the Commodity Exchange Act

-The Manager and its affiliates also manage other funds that invest in physical silver bullion and other assets that may be held by the Trust, and conflicts of interest by the Manager or its affiliates may occur

-The Trust’s obligation to reimburse the Trustee, the Manager, the underwriters or certain parties related to them for certain liabilities could adversely affect an investment in the units

-Unitholders may be liable for obligations of the Trust to the extent the Trust’s obligations are not satisfied out of the Trust’s assets (KD: ZOINKS!)

Appendix 3: “Hey Kid Dynamite – don’t you know that SLV says they won’t test their silver bullion?  It could be aluminum covered play dough!”

Yes, I know that, and guess what, PSLV doesn’t test their bullion either.  Both SLV and PSLV require London Good Delivery Bars – which is a standard of its own – and thus do not dispense with assaying their silver.   London Good Delivery Bars are the standard for silver bullion and are assumed to be “silver good.”

Appendix 4: “Hey Kid Dynamite – you are a paid shill for Barclays/JP Morgan/Blackrock/Bernanke/ blah blah blah

No, I’m not, I’m a guy who lives in the woods of New Hampshire, makes maple syrup, pickles, and will be raising chickens this year.  I don’t give two craps about Barc/JPM/Blackrock/The Fed, it’s the poor saps who are being misled with bad information that I am trying to help.

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The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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