Does the SLV Have Any Silver?

The iShares Silver Trust (SLV) has been the subject of controversy since it first started trading. The objective of the exchange traded fund, according to the iShares website "is for the value of the shares of the iShares Silver Trust to reflect, at any given time, the price of silver owned by the iShares Silver Trust at that time, less the iShares Silver Trust's expenses and liabilities." That is, there's supposed to be a vault somewhere with a bunch of physical silver and each share of the SLV is supposed to represent about an ounce.

Three main parties are responsible for the SLV. The sponsor, iShares, is a subsidiary of BlackRock (BLK). It arranged for the creation of the trust and its listing on the NYSE Arca. It assumes certain marketing and administrative expenses of the trust.

The trustee is Bank of New York Mellon (BK). It is responsible for the day to day administration of the trust, including processing orders, coordinating with the custodian, calculating the net asset value of the trust, and selling the trust's silver to pay for expenses.

The custodian is JPMorgan Chase (JPM). It is responsible for holding the trust's physical silver in its vaults. The prospectus states that JPM "is responsible to the trustee [Bank of New York] only. Because the holders of iShares are not parties to the custodian agreement, their claims against the custodian may be limited." Interesting.

The controversy is whether there is a vault that actually contains the amount of silver iShares says it does. Mainstream media hasn't weighed in on one side or another, but the blogosphere and Youtube are full of various accusations and speculation.

An interesting thing happened a day or so ago. According to Zero Hedge, Kevin Feldman, managing director of iShares issued a refutation of the rumors that the SLV contains no physical silver.

This reminds me of the CEOs of Bear Stearns and Lehman Brothers saying everything is fine shortly before their banks collapsed. It's also reminiscent of the other Wall Street CEOs saying everything was great and they didn't need to borrow any money while they were borrowing billions and teetering on the edge of insolvency. It also brings to mind the often quoted phrase, "never believe anything until it's been officially denied."

People are suspicious of the SLV for a number of reasons. Here are two.

First, there is a silver shortage. Eric Sprott, who runs, among other things, a physical silver fund (PSLV), has commented often in the recent past on how hard it is to buy physical silver in large amounts. Various mints, including the US Mint, are also unable to get sufficient supplies.

Second, the silver shortage has caused premiums for the physical metal to skyrocket. Sprott's fund has traded in recent days at about a 20% premium to the spot price. Silver coins at shops like the American Precious Metals exchange sell for a premium of over 9%.

Add these two together and it seems really weird that the SLV can increase and reduce its silver holdings daily seemingly with no trouble. For example, they decreased their holdings by 33 metric tons on Thursday.

All the data is available on the iShares website in the left hand column. Here is a chart of the trust's silver holdings since the start of April:

How is it possible for the SLV to buy and sell such large quantities of silver on a daily basis when no one else, it seems, can do so? It's expensive to procure physical silver, and usually takes much longer than a day. Transportation costs would presumably also present a problem.

According to the Inspection of Silver Bullion document on the SLV website (dated July 2010), there are two vaults operated by JPM, two vaults operated by Brinks Global Services, and one vault operated by Via Mat International. That makes five vaults in total with subcustodians operating three. What comes to mind is guys with forklifts moving bullion from one part of a warehouse to another, into the account of another silver market participant. So, for example, when the SLV dumped 33 metric tons of silver the other day, guys on forklifts in one or more warehouses moved the silver from Bank of New York Mellon's account to the accounts of whoever bought it.

The portion of the SLV prospectus that deals with the custodian seems to suggest that this is what takes place. (I say seems because I read it a number of times and am still not quite sure I understand it. It's among the more convoluted things I've read in my life, and I'm a law school graduate. I doubt that the obfuscation in the prospectus is accidental.)

But another question arises. How are buyers and sellers so readily available daily? Buyers at the moment are not a problem, given that there is a shortage. Sellers, on the other hand, are presumably hard to come by. (Maybe the custodian deposits the silver into its own accounts and then sells it back to the trust? I'd like to know.)

Moreover, can the prospectus and inspection certificate be trusted? Banks are not generally regarded as the most honest businesses, as one scandal after another has shown.

Banks have a particularly sordid history with silver. Here are a couple of recent examples.

There's currently a class action lawsuit against UBS that alleges the bank sold investors phantom silver. The plaintiff alleges that he bought silver bars from UBS, paying the bank monthly storage fees. After a while he decided to store the bars himself and demanded delivery of the metal. UBS didn't comply. After a series of ever more frustrating queries, plaintiff finally learned that UBS never purchased silver bars for him. The bank eventually responded, in a purposefully confusing letter, that he would have to sell his current "unallocated position" and buy "a silver position," at additional expense. So the plaintiff paid storage fees for no reason at all. And all that time the bank had apparently led him to believe that he had "a silver position," that is, specific silver bars segregated for him in a vault.
In 2007, Morgan Stanley (MS) agreed to pay $4.4 million dollars to settle a suit that alleged a similar scheme. In that case Morgan Stanley claimed that it followed industry practices. It has been suggested that "banks are in the habit of keeping only 1 bar for every hundred that are supposed to be in their vaults." If it's industry practice to make investors believe they're purchasing physical silver when in fact they are not, it is conceivable that the same sort of thing is involved in SLV. Given that JPMorgan, the custodian of the silver in SLV, has been investigated for silver manipulation I would say that more than conceivable, it is likely. How many claims are there on the allocated bars in the five vaults?

So, to summarize, there have been rumors and questions about the SLV's silver holdings. A banker from BlackRock took the time to officially deny these rumors. That's suspicious. The SLV prospectus in its vague language suggests that there is actual physical silver owned by the trust. It also answers, sort of, some of the questions regarding how such vast amounts of silver are bought and sold daily while other market participants have to wait weeks and months for delivery. But bankers have historically not been very honest people in general and their recent activities with silver do nothing to assuage people's suspicions.

Since BlackRock's official denial will most likely backfire, instead of directing investors to the prospectus Mr. Feldman should answer some of the more practical questions that people have in simple language.

Disclosure: Long physical silver.


Does the Government Own Big Business or Does Big Business Own the Government?

It's become somewhat commonplace for those people who follow and comment on current events, often in the middle of a rant, to claim that the banks own the government. Every once in a while, during the same diatribe the converse is uttered: the government owns the banks, as the bailouts continue and ever more public funds are used to cover private losses.

On these occasions, corporate or government apologists are quick to jump on the seeming contradiction. The original speaker, whether a demagogue or one who genuinely concerned about the current state of affairs, is quickly dismissed as a conspiracy theorist.

But there is no contradiction, because slowly but surely big business and the government have merged here in the USA and other nations. We should all be familiar with it by now, whether we call it a kleptocracy, crony capitalism, or by some other name.

Crony capitalism works on multiple, interrelated fronts.

First, corporations finance the campaigns of everyone who has a shot of getting elected, giving the most money to incumbents. They also spend billions lobbying those politicians that are in office.

What do they get in return? The laws that are passed are usually favorable for the corporations doing the lobbying, and often the laws are written by the lobbyists themselves. For example, Altria (MO) had its lobbyists distributing summaries of regulations displaying "an intimate knowledge of the bills far in advance of any public notification." Could it be because they drafted or had a lot of input in the drafting of the bills?

Second, there's the revolving door between big business and high ranking positions in the government. It involves someone going back and forth between being an industry executive, attorney, lobbyist, or other agent and either heading an agency that regulates the industry or being an elected representative.

For example, Michael R. Taylor worked for the FDA as an executive assistant to the Commissioner. He left the government to work for a law firm that represented biotech firm Monsanto (MON). There, he established the firm's food and drug law practice. A decade later, Taylor returned to the FDA as Deputy Commissioner for Policy. He then got a promotion, working for the USDA as Administrator of the Food Safety and Inspection Service. Taylor left this post for a short stay at his former law firm before joining Monsanto as Vice President for Public Policy. Taylor is back at the FDA, now Deputy Commissioner for Foods.

Do you think Taylor has any conflicts of interest while he works for the government regulating the very industry that holds his next job? Was it mere coincidence that the policies Taylor worked on for Monsanto became FDA policies?

(Taylor is, of course, one among many in government who works for Monsanto. For example,  Craig Stapleton, former US Ambassador to France and the Czech Republic, wanted to punish France for resisting Monsanto's genetically modified seeds.)

So that's the agritech business. How about energy? Here's one example. Steven Chu is the current Secretary of Energy. Before this post, he had founded the Energy Biosciences Institute at Berkeley, funded by a $500 million grant from BP (BP) of Gulf oil spill fame. BP's chief scientist, Steven Koonin, made the grant. Guess where Koonin works now? That's right, the Department of Energy as Chu's undersecretary. Care to wager where both of these gentlemen will work after they leave their government posts? (Speaking of BP, the oil giant has friends in the British Government too.)

Name an industry and a regulatory agency. You'll find that the regulators have worked or will work in the future for the very companies that they regulate. There are thousands of examples of the interconnectedness of government and big business.

Since this post began with banks let's end it there.

The Business Insider, fraudster Henry Blodget's outfit, has a small list of revolving door bankers, going back to 1934. The real list is much bigger.

The following is from Rolling Stone:

Criminal justice, as it pertains to the Goldmans and Morgan Stanleys of the world, is not adversarial combat, with cops and crooks duking it out in interrogation rooms and courthouses. Instead, it's a cocktail party between friends and colleagues who from month to month and year to year are constantly switching sides and trading hats. At the Hilton conference, regulators and banker-lawyers rubbed elbows during a series of speeches and panel discussions, away from the rabble. "They were chummier in that environment," says Aguirre, who plunked down $2,200 to attend the conference. [Gary Aguirre was an SEC investigator who got fired for questioning why the agency didn't pursue an insider trading case against John Mack, now chairman of Morgan Stanley.]

Aguirre saw a lot of familiar faces at the conference, for a simple reason: Many of the SEC regulators he had worked with during his failed attempt to investigate John Mack had made a million-dollar pass through the Revolving Door, going to work for the very same firms they used to police. Aguirre didn't see Paul Berger, an associate director of enforcement who had rebuffed his attempts to interview Mack — maybe because Berger was tied up at his lucrative new job at Debevoise & Plimpton, the same law firm that Morgan Stanley employed to intervene in the Mack case. But he did see Mary Jo White, the former U.S. attorney, who was still at Debevoise & Plimpton. He also saw Linda Thomsen, the former SEC director of enforcement who had been so helpful to White. Thomsen had gone on to represent Wall Street as a partner at the prestigious firm of Davis Polk & Wardwell.

Two of the government's top cops were there as well: Preet Bharara, the U.S. attorney for the Southern District of New York, and Robert Khuzami, the SEC's current director of enforcement. Bharara had been recommended for his post by Chuck Schumer, Wall Street's favorite senator. And both he and Khuzami had served with Mary Jo White at the U.S. attorney's office, before Mary Jo went on to become a partner at Debevoise. What's more, when Khuzami had served as general counsel for Deutsche Bank, he had been hired by none other than Dick Walker, who had been enforcement director at the SEC when it slow-rolled the pivotal fraud case against Rite Aid.

"It wasn't just one rotation of the revolving door," says Aguirre. "It just kept spinning. Every single person had rotated in and out of government and private service."

To say that the government owns this or that corporation and to say that this or that corporation owns the government is not a contradiction. It is to say the same thing. Many of the higher ups currently at big business will fill government posts in the future. And many current government workers in positions of power will in the future get corporate jobs in the same industry they're supposed to regulate, and the cycle will continue.

The knee jerk reaction is to say that all these people are evil. I'm inclined to think so, but the whole system is broken and corrupt.* The only incentive, as Mr. Aguirre found out, is to work in the interest of big business to the detriment of everyone else. As far as the system goes, the door revolvers are no more culpable than the poultry workers who mindlessly debeak baby chickens all day. If they won't do it, someone else will.

Disclosure: At the time of writing I might've been guilty of some hypocrisy by owning shares of Altria (MO).

*The system designers were aware of this problem from the start. James Madison, for example, in the Federalist 10 gave a halfhearted argument that while special interests posed a threat they would be so numerous as to cancel each other out.


Looking for a Near Term Top

Helicopter Ben's second debt-monetizing program (QE2) is supposed to end in June 2011. The market, and precious metals especially, seems to be pricing in a third quantitative easing program.

And that is the general consensus. The most common views range from Bernanke can't stop printing money because if he does everything will collapse to he'll stop for a little while before the fake economic numbers take a dive and he's forced to start up the printing press again. Less common is the view that since the US dollar is the world's reserve currency, Bernanke can print as much as he wants.

Whenever there's a set date by which some major market supporting activity is supposed to conclude (e.g., 2008 Summer Olympics in China, QE1, etc) the market tends to go up with investors thinking something like, "it's safe to buy [until the set date]." Usually, at some point before the expiration of the market supporting activity, people decide to sell ahead of everyone else. The market logs a top when the sellers outnumber the buyers. In the case of the Chinese Olympics, for example, the top in Chinese stocks was reached at the end of April 2008, a full quarter earlier than the "safe to invest before August" mantra insisted.

So, QE2 is supposed to end in June. Will investors start to sell before that date? I think it's quite possible. Another possibility is that they'll continue pricing in QE3. If that's the case, whatever the Fed announces in June (QE3 or no more QE) will likely produce a sell off if one hasn't already occurred by that time. Of course, this comes with the often repeated caveat that the market will do what it wants regardless of the could'a, would'a, should'a.

To the above speculations I'd like to add the following.

Zero Hedge reports on NYSE leverage: In February 2011, "total Margin Debt jumped from ($46) billion to a massive ($57) billion. This is the third lowest net worth reading ever reported by the NYSE. Only the ($67.8) billion in May 2007 and ($79) billion in June 2007 are worse, and confirm that everyone is levered to the gills at virtually the same level as when the market was at its all time highs." As of writing, March 2011 figures aren't available. They'll be published here.

After a bounce, the Baltic Dry Index has resumed its course downward since the end of March. The index, which tracks worldwide shipping prices of dry bulk goods, is regarded as an indicator of future economic activity.

Copper, another early economic indicator, may be turning over, according to Goldman Sachs (GS). Goldman should in no case be blindly trusted, the thieves that they are, but they do occasionally dispense accurate information to their clients. That the economy is much worse than we're told and that copper prices are perhaps too high might be gleaned from an indirect source: people are now stealing the metal to make money. Another indication of the same thing is that the nickel, the $0.05 denominated US coin that is composed of 75% copper and 25% nickel, as of April 15, 2011, has a melt value of $0.068. That's 36% higher than its face value.

With the first quarterly reports coming out last week, the earnings picture isn't all that rosy either. Alcoa (AA), Bank of America (BAC) and Google (GOOG) all disappointed.

Company insiders started selling in January, continuing in February and March. On the other hand, retail investors, otherwise known as bag holders, have been buying.

Oil is over $100 a barrel, and gas prices in most areas in the US are over $4 a gallon. While Morgan Stanley says this isn't bad for the economy, one may wonder just how long this "wealth redistribution" can last given that rising oil prices are like an additional tax on the public, which must drive or use public transportation to get to work, if they even have a job. Oil prices don't just affect the price at the pump. Most of the goods that are moved from place to place (pretty much everything we buy in the store) incorporate transportation costs in their price. We also pay more for things packaged in or made out of plastic, which is made out of oil. Our economy runs on oil.

Finally, the market hasn't had a significant correction in quite some time. Add to this the overwhelmingly bullish investor sentiment. "Only 15.7% of investors are bearish--the lowest reading in 20 years."

Maybe the market will never go down again, but if there were ever a good time to sell in May and go away, it is now.