The Ultimate Investor Guide To Silver ETFs

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October 11, 2013 4:13pm NYSE:AGQ NYSE:SIL

silver-etfPrecious metals like gold and silver have been performing quite poorly of late due to the continued strength in stock markets. The white metal has been beaten down significantly in 2013, underperforming broad stock markets by a pretty wide margin.

In fact, the white metal has plunged nearly 30% in the first nine months of 2013, pushing the commodity to fresh lows. Many feel that this weakness could continue too, especially if investors continue to look to stocks for exposure and shun commodities.

Uncertain Global Trends

Silver prices will likely remain under pressure in the short term due to sluggish fundamental factors in the global markets. The U.S. economy is improving but China, which is considered the biggest industrial fabricator after the U.S., is still seeing sluggish economic growth.

Additionally, tepid industrial demand is impacting the price of the bullion as about 50% of the metal’s total demand comes from industrial applications. Further, the growing speculation over the early end of the Fed’s stimulus program (QE3) is lowering the demand for silver and silver ETF holdings (read: Commodity Slide Hits Silver ETFs).

Based on these negative fundamentals, Morgan Stanley slashed its 2013 and 2014 silver price forecasts by 19% and 15%, respectively. Another firm, Bank of America Merrill Lynch, also cut its silver target by 25% for 2013 and warns that the price could fall further below $20 per ounce in the coming months.

All these factors suggest a bearish trend for the white metal at least for the short term.

Silver’s Upside

However, the long-term prospects look tremendously bullish given the growing demand from emerging products, China’s introduction of silver futures and high fabrication demand, which make up roughly 80% of silver demand.

Even the demand for traditional products like silverware and jewelry have been held steady during these hard times.

Furthermore, continued government dysfunction is decidedly bullish for the metal, as it can act as somewhat of a safe haven during troubled times. Should government problems hit investor confidence, silver could be a solid, and safe investment.

As a result, investors should reap huge benefits from this beaten down metal, which has temporarily been held back due to a slowdown in demand and weak global fundamentals. For those seeking to take advantage of the dips in the metal, an ETF approach could be a great idea as it offers up an extremely liquid way to target the space.

Types of Silver ETFs

Silver ETFs are divided in three categories: futures, physically backed ETFs and mining ETFs. Each of these will be detailed for investors looking to play in this increasingly important bullion market (see more in the Zacks ETF Center):

Physically Backed Silver ETFs

These funds offer simple and cost-efficient ways for investors seeking exposure to silver bullion. The ETFs seek to match the spot price of silver, net of fees and expenses and own silver bars to back the shares.

Each share represents a fractional interest in the trust. The two largest and the most popular silver ETFs in the space are iShares Silver Trust ETF (NYSEARCA:SLV) and ETFS Physical Silver Shares (NYSEARCA:SIVR).

With total assets of $7.4 billion, SLV tracks almost 100% the physical price of silver bullion measured in U.S. dollars, and kept in London under the custody of JPMorgan Chase Bank N.A. Each share represents about an ounce of silver at current prices. On the other hand, SIVR has AUM of $390 million and is backed by physical silver under the custody of HSBC Bank USA in London.

Though not a low-cost choice due to its 50 bps expense ratio, SLV has a lower bid/ask spread which could make total costs slightly less for this popular fund. SIVR charges only 30 bps in fees a year making it the best low-cost choice in the silver commodity space. While this is good, the bid/ask spread is probably wider than what investors see in the iShares product.

Both the products lost significantly in the first half of 2013 due to weak performance by the white metal. However, these are expected to rebound in the long term thanks to a strong outlook for industrial uses.

Recently, Credit Suisse launched Silver Shares Covered Call ETN (NYSEARCA:SLVO) that seeks to give investors a new way to play the precious metals market. These employ a covered call strategy which looks to provide investors with a great deal of income while still offering exposure to the metal.

This approach does cap risk, though big gains are unlikely with this ETN either. Still, the product has easily outperformed SLV since its inception, and if current trends hold, will sport a double-digit yield as well.

However, it is worth noting that this product has paltry volumes which could result in higher bid/ask spreads and increased trading costs. This makes the note a bit pricey as its expense ratio already comes in at an elevated level of 0.65%.

Still, in flat or down markets, a covered call strategy can be an interesting play, and one that can outperform ‘regular’ silver ETF investments (read: Time to Buy the Covered Call Silver and Gold ETFs?).

Futures-Based Silver ETFs

These ETFs track the performance of the white metal using instruments such as futures. Investors seeking exposure to this category have a variety of options to choose from:

The top fund in the category is PowerShares DB Silver ETF (NYSEARCA:DBS) which provides exposure in the futures market rather than spot market and tracks the DBIQ Optimum Yield Silver Index Excess Return index, before fees and expenses.

The index comprises silver future contracts and the fund was launched in January 2007. Since then, the ETF has been able to amass an asset base of $37 million.

The product is the high cost choice in the silver bullion space, charging 79 bps in fees per year from investors. Additionally, it has a wide bid/ask spread given its small average daily volume of 14,000 shares that increases the total cost of the product. Not surprisingly, the ETF is extremely volatile given its focus on futures contracts which can be more volatile than spot prices.

Second comes the ETFs issued by ProShares – Ultra Silver ETF (NYSEARCA:AGQ) and UltraShort Silver ETF (NYSEARCA:ZSL) initiated in Dec 2008. These funds seeks to deliver twice (2x or 200%) the daily performance of the silver bullions in U.S. dollars, with the silver price fixed for delivery in London.

The former has a direct relationship with the price of silver while the latter has an inverse relationship. So ZSL makes a profit when the silver market declines and is suitable for hedging purposes against the fall.

AGQ has amassed $555 million in its asset base while ZSL has a relatively lower AUM of $107 million. These ETFs do not invest in silver bullion directly; rather, these use financial instruments (swap agreement, future contracts, forward contracts and option contracts) to gain exposure to the precious metal.

This indirect approach might introduce additional tracking errors leading to extra cost. Already, investors need to pay 95 bps in fees per year, which is expensive when compared to other geared options in the space.

Despite high costs, AGQ trades with a good average daily volume of roughly two million shares but performance has been quite volatile, to say the least (read: Guide to The 10 Most Popular Leveraged ETFs).

In Oct 2011, another issuer, VelocityShares, initiated two similar ETNs – 3x Long Silver ETN (NYSEARCA:USLV) and 3x Inverse Silver ETN (NYSEARCA:DSLV) but with three times (3x or 300%) exposure. The products seek to replicate the daily performance of the S&P GSCI Silver Index Excess Return plus returns from U.S. T-bills net of fees and expenses.

USLV, having AUM of $137.0 million, provides long exposure to 3x the daily performance of the index while DSLV, having AUM of $31 million, provides 3x the inverse exposure. The ETNs are the high cost choices in the silver bullion space, charging 165 bps in fees per year from investors.

Investors should note that since these products are extremely volatile, these are suitable only for traders. Additionally, the daily rebalancing—when combined with leverage—may make these products deviate significantly from their expected long-term performance figures.

Investors seeking exposure to a portfolio of commodity futures through a single investment may consider E-TRACS UBS Bloomberg CMCI Silver ETN (NYSEARCA:USV). The ETN seeks to replicate the performance of the UBS Bloomberg CMCI Silver Total Return index, net of fees and expenses. The product delivers collateralized returns from a basket of silver futures contracts, which are diversified across five constant maturities ranging from three months to three years.

This silver ETN is unpopular and attracted only $12 million in its asset base while charges 40 bps in annual fees from investors.

Equity-based Silver ETFs

The fund in this category mainly tracks the index consisting of silver mining and exploration companies. There are 3 ETFs available in this category:

Global X Silver Miners ETF (NYSEARCA:SIL)

The fund, issued by Global X in Apr 2010, seeks to match the price and yield of the Solactive Global Silver Miners index, before fees and expenses. The index measures the performance of the global companies that are actively engaged in some aspect of the silver mining industry, such as silver mining, refining, or exploration.

With holdings of 32 securities, the product is nearly 70% concentrated in the top 10 firms, which include Silver Wheaton (SLW), Fresnillo (FNLPF) and Industrias Penoles. The fund focuses on small cap companies, as these account for 55% of the total assets. In terms of country exposure, Canada takes the top position with 56% share while Mexico and U.S. round off to the next two spots with 23% and 15% share, respectively.

The product has attracted assets worth $210 million, while charging investors 65 bps in fees a year.

iShares MSCI Global Silver Miners Fund (NYSEARCA:SLVP)

This ETF tracks the MSCI ACWI Select Silver Miners Investable Market Index. This benchmark measures the performance of companies in both developed and emerging markets that derive the majority of their revenues from silver mining.

The product holds 31 stocks in its basket and is highly concentrated in its top 10 holdings. The top two firms – SLW and Industrias Penoles – make up for a respective 21.58% and 11.50% share. Other securities hold no less than 6.83% share in the basket.

Canadian companies take half of the portfolio while U.S. and Mexican companies get double-digit allocations with 18.09% and 11.50% share, respectively (read: Why Mexico ETF is a Long-term Winner).

The fund is unpopular with just $6.0 million in AUM and charges 39 bps in annual fees.

FactorShares PureFunds ISE Junior Silver ETF (NYSEARCA:SILJ)

This ETF follows the ISE Junior Silver Miners Index, holding 29 stocks in the portfolio. The stocks in the fund include silver mining exploration and production companies. It focuses on small cap securities.

The product puts roughly 64% of total assets in the top 10 holdings. Mag Silver (MVG), Fortuna Silver Mines (FSM) and Mandalay Resource are the top three elements in the basket.

Here again, Canada (84%) takes the top position in terms of country exposure. Firms from the U.S., Hong Kong, and China make up for the remaining positions in the basket.

The fund has AUM of $1.7 million and an expense ratio of 0.69%.

This article is brought to you courtesy of Eric Dutram.

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