The Morgan Report Blog

Why Physical Silver Investors Love ETFs – But Not Owning Them

Why Physical Silver Investors Love ETFs – But Not Owning Them
by Jeffery Lewis

Despite the various reasons silver investors should not buy exchange-traded funds and instead opt for physical metals, there are also many reasons why investors should love them.

ETFs Increase Precious Awareness

Before silver and gold were spotlighted for their extreme gains, only a small percentage of investors even had proper allocations of physical metals in their portfolios.  In what was a huge oversight for the average investor, silver and gold began their run upwards in price as stocks fell. 

Several years after the rise in metals pricing jumpstarted, exchange-traded fund sponsors begin to release slews of funds that were designed to track the changes in the price of precious metals.  Today, ordinary investors can’t open the Wall Street Journal or turn on the news without hearing about precious metals investing and popular ETF choices.  If you’re looking into investing in silver today, you most likely first heard about them via the popular derivative products on Wall Street.

 

ETFs Drive up Prices

 

Few can deny the impact large exchange-traded funds have on the commodities markets, especially those that claim to be “physically backed” by holdings in bank vaults.  These funds have to invest every dime they receive into precious metals holdings and ultimately drive demand, as well as prices.  One otherwise unrelated ETF, the United Natural Gas Fund, at one time held as much as 60% of the front-month futures contracts for natural gas.  As you can see, these market behemoths have a dramatic impact on prices.  However, they aren’t driving prices down; they’re driving them up!

ETFs Open to a Trillion Dollar Market

Retirement accounts are one place you’re unlikely to see a commodity investment category, and you will certainly never see one for precious metals – until now.  A variety of exchange-traded fund sponsors are lining up to encourage corporations, as well as investment companies, to list their ETFs among 401k plans and other products.  Retirement planning is a trillion dollar business which controls immense amounts of investors’ monies.  Should ETFs break into the mainstream 401k account, it’s likely that precious metals will be even more in demand and rise equally in price.

One Reason to Hate ETFs

Of course, exchange-traded funds are not all bright and shiny.  One of the many reasons investors should buy physical metals rather than paper metals is due to high annual fees that most exchange-traded funds charge.  There is simply no reason to give away some of your well earned returns just for the convenience of getting a paper statement as to how well your holdings are performing. 

For example, the iShares Silver Trust ETF (SLV) charges a whopping .5% annual fee, negating the returns you make on your silver.  If you invested $10,000 into SLV, a 10% annual return is worth $61,416 in 20 years.  On the flipside, investors who buy $10,000 in physical metals will have $67,274 in 20 years, which is a difference of $5,850.  Why give away those extra thousands of dollars, not to mention endure the risk of “paper” metals?   

While we can love exchange-traded funds for bringing thousands of investors into the world of precious metals ownership, as investors, it makes little sense to own them ourselves, especially at a cost of $5,850 on a relatively small $10,000 investment.

David Morgan on the Junior Miners

9/2/2009
by John Rubino

The precious metals juniors have had a nice pop in the past few months. But according to David Morgan, veteran silver analyst and publisher of The Morgan Report, the real fun is just beginning. We spoke recently about why the sector has a bright future and how to tell the real companies from the story stocks.

DollarCollapse: Why do the juniors look good right now?

David Morgan: First of all, they’re still undervalued. There are projects out there that are selling for less than their cash on hand. Many more are selling for less than a reasonable liquidation value. Once you’re on the floor you can push as hard as you want and you’re not going below the floor, so the juniors look like the best part of the resource sector at the present time.

The only negative is that we’re approaching more volatility in all the markets. There is a possibility in my view that there could be one more smashing of the general financial sector. The large miners tend to go along with the general equity market. So a huge sell-off in the stock market in October would damage the large cap miners such as Newmont Mining and GoldCorp. Will it take down the juniors? Probably not. You might see some of these stocks sell off a bit, but they’re already washed out.

DC: How big a part of the story is M&A, with the majors buying up the juniors?

DM: It’s a very big part of the story. Basically when the credit crunch started to manifest globally in 2008, companies that had cash positions were sitting like vultures on the telephone line looking at the companies with good projects that were selling at less than asset value. Lots of mergers and acquisitions took place. The big companies didn’t have any problem at all getting credit.

But I don’t spend a lot of time looking for potential takeovers. I approach these companies on a value basis. With commodities, whether you get metal out of the ground in Canada or South Africa, it’s all the same, it’s fungible. So with a big company what you want to look for is the balance sheet and income statement. Who’s making the most profit on the same product? I’m simplifying but that gives you the general idea. But move down to the juniors and that’s more of an art, a much more difficult process. Where are they, who’s managing it, how much cash do they have in the bank, have they done it before? But some of these projects are only so far advanced and they’re in good shape but are sitting there without anyone other than bigger companies paying attention.

DC: But you don’t like “story stocks”…

DM: I’m conservative, which comes with experience. I started in this sector at a very early age and was going to get rich quick. I bought every penny stock on the Vancouver exchange that I had money for, and my thinking was that if I just picked the right juniors it would just be a question of waiting a fixed amount of time and these things would go to the moon. But then I calmed down, saw my losses, and started to learn more. The truth of the matter is that on a grassroots exploration company your shot is about one in 2,000. That’s better than the lottery but it’s not as advantageous as a lot of people think. So part of my job is to separate the real companies from the story stocks. Again, I want to state that I am not primarily a junior mining stock picker, I focus much more on making money safely in the sector much like someone managing a gold fund, but we do not manage money.

DC: What do you need to see in order to move a company from story to real?

DM: You need to see the story coming true according to plan. There’s a sweet spot to buy a stock and it’s always higher than where it was when it started. When a company is just an idea or a great story, that’s usually as cheap as it’s going to get. Very few great stories come true, but if it begins to come true, the market will bid it up. But it can still be undervalued. And once you know a lot about it, let’s say 80% comes true and the other 20% is coming, there’s a point where there’s enough volume and news and knowns-versus-unknowns that you can buy the stock pretty safely and still see a lot of upside. I’d rather buy a $2 stock that goes to $8 in a year than a stock at 12-cents that takes ten years to go to $8.

We had Silver Standard (SSRI), for instance, at 65 cents. I was one of the first other than Adrian Day to recommend it, but [later on] you could buy that stock at $5 and still have a lot of upside. They kept adding shares but at the same time they were adding more silver ounces per share. So there’s your sweet spot: For a while you could buy something that was getting more undervalued the more shares they issued.

DC: So who are the next Silver Standards out there?

DM: I don’t think there will be another Silver Standard for a while but I’ll give you a conservative pick. Energold (EGD.V) is a drilling company with a unique drill that’s used all over the world. It’s a very efficiently run company, with management that’s excellent. The sweetener on this one is that it owns a pretty good percentage of Impact Silver (IPT.V). They’re mining silver at a profit, a small operation with lots of growth potential. So you’ve got an operating company with solid contracts and a pretty good slice of Impact Silver. This is as solid a speculation as any on our list.

One of my earliest recommendations is Mines Management (MGN). I know the management quite well. It’s developing a huge property, over a billion pounds of copper and a quarter million ounces of silver in Montana. It’s not a super-rich project. It’s been advanced substantially over the last several years but they’re not mining yet. If something happens in the future they don’t have a fallback position, so this adds to the risk. However, it’s so undervalued that it’s a reasonable speculation. If you put this on a graph of ounces in the ground per dollar invested it’s well undervalued relative to its peers.

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