Long (John) Silver?
It’s late April and you are late to the party regarding the trajectory of the gold price. Worry not, silver is catching up and is steaming higher - buy a twice leveraged silver ETF (LSIL) and pay for your summer. Or short silver ETFs and enjoy the free fall in the above instruments over the last 10 days after margins were raised at the silver commodity exchange (The Financial Times). Whichever way you were positioned it is another topical talking point for this rampant asset class. We can review the latest ETF news to see who is reacting to the goading from the FSB/IMF/BIS report and hear titbits from the Index Universe conference in Amsterdam today. We also highlight the arrival of a new optimized index aimed at improving liquidity, the NASDAQ 100 Data Explorers Optimized Index.
The Easter rollercoaster in silver helps remind everyone of the massive volatility difference between equity backed funds and commodity ones. In truth, silver ETFs are actually Exchange Traded Commodity funds (ETCs), which is a key difference. But for investors with their eyes open, this presents a fabulously rich vein of choices during this stomach churning ride.
If these instruments were not available, plain silver mining companies like Fresnillo (LSE:FRES) were the only option. On the 28th April, the main silver fund (iShares Silver Trust - NYSE:SLV) was up 30% compared to a 10% rise in the price of Fresnillo [LSE:FRES]. So far so good for those ETF traders – no individual company risk and a return three times higher.
Those that felt this difference in price was evidence of retail speculation could sell their holdings and walk away. As an alternative, they could have shorted the iShares Silver Trust (NYSE:SLV) or taken out protection in the options market. There were 12 million shares short for SLV or 3.5% of the market cap last week. Then there was so much insurance being bought in the options market on the 27th April that there were more silver related contracts being struck than those based on the movement of the overall S&P500!
On the above evidence, if you smelt a bursting bubble at this point and felt brave you would have bought the ETF that went up when the price of silver went down. The Proshares Ultrashort Silver (NYSE:ZSL) went up twice the value that silver went down. There were a few genius institutional investors out there who did precisely this! Those funds who lend their assets increased their holdings in ZSL from 200,000 shares to 1.55million shares between the 18th April and the 3rd May, making a handsome return as silver fell.
As the situation calms down, the scores on the doors are as follows. Leveraged silver funds are down 65% and one imagines the inverse Ultrashort is positive something similar. Meanwhile, back in the smooth and steady world of single stock investing, Fresnillo is down around 7%. Some would argue the ETCs have created a wealth of choice.
Following all the accusations about counterpart risk, collateral risk and a lack of transparency we are already seeing a reaction to this. The Credit Suisse ETF products provide daily collateral schedules alongside Deutsche, ETF Securities and others. Every week more transparency is offered up and it the willingness to offer it was a theme in yesterday’s Index Universe summit on ETFs.
We also need to remember that the ETF/ETC providers simply offer a security that tracks an index. If this index swings wildly during moments of volatility it is the index providers’ issue rather than the ETF. Take the Leveraged Silver ETC. It is based on the Dow-Jones-UBS index. It is the ETF’s fault alone if the instrument has a big tracking error with the index. This is why we should expect to see many more Optimized indexes, such as the one NASDAQ OMX have created using Data Explorers data NASDAQ-100 Data Explorers Optimized Index (NASDAQ:NDXOPT). This eliminates hard to borrow names thereby making it an easier index for people like Source and ETF Securities to create resulting in cheaper costs for all, while retaining the performance of the original index.
As ETFs and ETCs gather momentum, eyebrows naturally get raised. Many people are questioning their composition, efficiency and ability to track their underlying components. They are asking whether the counterpart selection is probing in the right areas and if greater transparency will make the ETF industry stronger in the long term (assuming the providers continue to respond with more transparency).
Regulators need to consider that indexes are, and always will be, quirky. For instance, did you know that Switzerland’s main index basically reflects the movements of single massive company given that Nestle makes up around 20% of the index, as revealed in the comments posted to a lively Index Universe debate. The FTSE100 is not a barometer of the UK’s economic health – it tells you now well financial and resources companies are doing.
Talking resources, the London market will be biased even further towards commodities with the upcoming IPO of Glencore (market cap expected in the $50-70bn range). If you don’t have the stomach to invest directly in ETCs, perhaps an investment in the experts might do the trick?
