SLV and Jeff Nielson

By Bron Suchecki, on October 6th, 2009
On Sep 17 Jeff Nielson posted an article on SLV. I took issue with his belief that ETFs’ management fees were unrealistically cheap and thus another indicator they were a scam. Below is the exchange between Jeff and I on the matter.

Bron: You say “custodians of the vast majority of all the world’s bullion-ETFs – a service which they are providing free of charge” but SLV has an expense ratio of 0.50%, some of which if I remember the prospectus correctly, is paid to the custodian. If SLV holders pay 0.50% how can it be considered “free”. By what do you mean free?

Jeff: Hi Bron. Just look at all that is SUPPOSEDLY covered by this 1/2% fee:

1) Transaction costs. Purchases must be made CONSTANTLY, all day long – in order to buy the actual silver for unit-holders at the same price they bought their units at. Given the huge volatility with silver, it’s not even feasible to restrict buying to once a day – since silver has had MANY daily moves of 5% or more.
2) Insurance/delivery costs
3) Storage/security costs.

Obviously BILLIONS of dollars of silver require significant security to guard such a hoard. The U.S. government has an entire military battalion guarding Fort Knox – so no one can find out how much gold is NOT there.If you think these costs are minimal, then answer this question: why do the small number of companies who hold their own bullion need to charge MANY times that premium for their own security/storage costs?

Bron: Before I comment, just want to state upfront that I work for the Perth Mint, but I am speaking here in a personal capacity. While I’m speaking personally, obviously the ETFs are competitors to my employer’s business, both in respect of physical coins and bars as well as our own storage facility, so I’m not any apologist for the ETFs. Taking each of your points in turn.

1) Transaction costs. I note that SLV’s average Bid Ask Ratio is 0.08%. This is very tight but is not necessarily unprofitable for a market maker. You are right that the market maker must be purchasing (or selling) gold constantly as it sells (or buys) SLV shares. My experience with the Perth Mint’s ASX listed product (code: ZAUWBA) is that the market maker will simply set their stock exchange price for an ETF higher than their cost on the wholesale over-the-counter market and adjust this constantly during the trading day. This way they always make a profit on transactions, it is not a cost to them. If individuals bid prices under this than the market maker misses out on a trade. It is only where there are excessive buyers or sellers that the market maker’s prices will get hit.

2) Insurance/delivery costs. Delivery costs are effectively zero, as the metal is most likely already in the vaults as sellers of physical need to bring their metal to London to trade it. Insurance is a real cost, but are easily covered by 0.50%. Important to note that the metal is not fully insured, just the first couple of billion (I don’t think the prospectus says anything about the first loss limit of the insurance). Once you get to a certain size therefore, the insurance cost is a fixed cost, not variable.

3) Storage/security costs. These are fixed costs, once you have a vault and have secured it, every additional ounce does not result in any change in costs. Once you get to the point that you have covered these fixed costs, every ounce above that is pure profit and this is where custodianship can be highly profitable. At 280 million ounces, SLV is definitely there in my opinion. Storage business is a classic case of economies of scale, which is why smaller companies have to have higher storage charges (eg Perth Mint allocated silver is 2.5% pa).

I have been a bit brief on explaining the above, but my view is that they are making money with a 0.5% expense ratio. That is why I think the “free of charge” line of attack is not supported and you are better off focusing on your other criticisms.

Jeff: Bron, at the time that SLV was created, there was only 200 million oz’s of silver in GLOBAL inventories. Now SLV and others hold close to 450 million oz’s. Obviously there MUST be both delivery AND insurance charges for AT LEAST 250 million oz’s of silver – which could NOT have “already been in vaults”.

As for security/storage costs, I’ll happily concede (for purposes of argument) that no new storage space was created. This brings me back to my point about the ludicrous idea of a BANKER (holding a massive short position) SUBSIDIZING “longs” by providing free storage/security.

Even if you subscribe to that ludicrous fantasy, there is still the issue of the “opportunity cost” to banks. Precious metals are not the ONLY items in the world for which there is a demand for high-security storage. Will ANYONE suggest that banks will provide a FREE service for precious metals longs – rather than charge someone a fee for storing other valuable assets? Try asking JP Morgan to store YOUR OWN precious metals for free – and listen to how hard they laugh at you.

Bron: “Obviously there MUST be both delivery AND insurance charges for AT LEAST 250 million oz’s of silver – which could NOT have already been in vaults”

You’ve missed my point. Lets assume the additional 250moz is real and was bought by bullion banks to back SLV & others. In that case, the bullion banks would incur no delivery charges as the seller delivers metal to London at their cost to be able to sell it on the spot market in London. Secondly, the additional 250moz has no insurance charges – as I said, they only insure the first $1b of holdings, not the entire holdings.

“the ludicrous idea of a BANKER (holding a massive short position) SUBSIDIZING longs by providing free storage/security” & “Will ANYONE suggest that banks will provide a FREE service for precious metals longs – rather than charge someone a fee for storing other valuable assets?”

Jeff, you keep on saying they are doing it for free when SLV charges 0.5%. Some of that 0.5% goes to the custodian, they are being paid. That is not “for free” – I don’t understand why you keep on saying they are providing free storage.

The question is whether the 0.5% charge is realistic, profitable assuming the volumes of metal SLV and others hold is physical. As explained in my previous reply it is. Saying this does not mean that they have physical, but nor does it mean they do not.

Jeff: Bron, your assumptions about delivery cost are only valid if you’re implying that silver (and gold) goes straight from refineries into bankster vaults – rather than having to be PURCHASED by the banksters (first) on the open market, and then transferred to their vaults.

When you mention the 0.5% fee charged by SLV, my understanding is that this also (supposedly) covers their OWN administrative costs AS WELL AS all the shipping costs, transaction costs, insurance costs, and storage/security costs.

You would be hard-pressed to find any ONE bankster service (in ANY of their business activities) which they are willing to provide for a 0.5% fee. Suggesting that they are willing to REDUCE their fees (to close to ZERO) to SUBSIDIZE the entry of longs into the market is simply nonsense.

Bron: “your assumptions about delivery cost are only valid if you’re implying that silver (and gold) goes straight from refineries into bankster vaults – rather than having to be PURCHASED by the banksters (first) on the open market, and then transferred to their vaults.”

No it doesn’t. There is no difference between purchasing from refineries or on the open market – refineries are all in different countries just like existing stocks. If market makers cannot acquire metal from investors or sellers already holding it in London, they will actually be able to acquire it at a discount to London spot (which is the usual state of the market), the discount equalling the shipment cost into London. Even if they have to pay a premium (or pay shipment costs into London), then they just factor this into their bid and ask prices quoted for SLV. This is why delivery is not a cost that comes out of the 0.5% fee.

“When you mention the 0.5% fee charged by SLV, my understanding is that this also (supposedly) covers their OWN administrative costs AS WELL AS all the shipping costs, transaction costs, insurance costs, and storage/security costs.”

The 0.5% does cover their administrative and compliance costs, but as I have discussed above and in my previous replies, any shipping and transaction costs are recovered via market making activities, so these do not come out of the 0.5%. As I have also replied, insurance and storage/security are FIXED costs, not variable, whereas the revenue of 0.5% is variable. This means that once you cover you fixed costs, the 0.5% on any additional metal is pure profit.

“You would be hard-pressed to find any ONE bankster service (in ANY of their business activities) which they are willing to provide for a 0.5% fee. Suggesting that they are willing to REDUCE their fees (to close to ZERO) to SUBSIDIZE the entry of longs into the market is simply nonsense.”

0.5% is not “close to zero”. On 280moz, 0.5% = $24 million, that is not anywhere near zero. The fact is that in the wholesale market storage is offered for much less than 0.5%. Do you remember David Einhorn’s Greenlight Capital exiting his GLD in favor of physical bullion? He did this because it was CHEAPER, in other words he could get storage for less than GLD’s 0.4%. In fact, quoting http://www.hardassetsinvestor/:

“By contrast, a $400 million player in the bullion market has substantial room to negotiate. You can be sure his [Einhorn] bullion holdings are being custodied for less than 12 basis points.”

If you believe that 0.5% is an unrealistic fee, a subsidised fee and therefore proof that SLV is a scam, then logically you must also believe that Bullion Vault, with a 0.12% storage fee, is also a scam. This puts you in a bit of a spot, because Bullion Vault is one of the most transparent operations in the market, and favoured by many goldbugs and commentators. Your stepping out on a limb here.

The post above was on Sep 21, Jeff replied to another post on Sep 22 but ignored mine. I posted the comment below on Sep 27. No response by Jeff as at Oct 4.

Bron: You have replied to someone else’s comment which appear after mine, but ignored mine. Does this mean you conceed on the issue of the reasonableness of the storage fee?



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John Hempton on the (hidden?) Losses of Spanish Banks

By Claus Vistesen, on October 6th, 2009

I am a sucker for a good argument presented with the correct dose of eloquence and cold facts, and John Hempton’s latest tour of the balance sheet of the Spanish bank BBVA is just that. Essentially, John sets out to address the question of whether Spanish banks are hiding their losses or, as John ultimately goes on to argue, frontloading their eventual losses by extending credit to bad debtors in stead of writing down on the balance sheet.

Of course, this is not only a question of the practices of BBVA and whether you buy John’s extrapolation from the case of BBVA to the case of the entire Spanish banking industry and on to the Spanish economy and the Eurozone itself, I believe the analysis and underlying points deserve a closer look. Personally, I do think that this is one of the most important questions we face in the context of the ongoing financial crisis, namely the extent to which the periphery of the Eurozone (and in particular Spain) harbour the ingredients to pull the whole edifice down or very close to the brink as a result of an unravelling which lies ahead in the beginning of 2010 as government and monetary stimulus begins to wane and/or the pressure from deleveraging and internal devaluation becomes too much.

Readers with a good memory or just a specific interest in this topic will remember the debate that arose in the context of the report by Variant Conception that essentially attempted to call the emperor, in the form of the Spanish banking industry, with not clothes. The VP report stirred up quite a flurry with for example an Iberian Equity piece that specifically targeted the arguments of Variant Perception. I have a good overview of the initial skirmish here if you want to read up on the background on this (although John draws up the playing field very nicely in his piece). As you will see, I am with the bears here, but I do think that we need to settle this with facts and good reason and to this end I would rate John’s piece very highly, even if it also tends to conform with my world view.

Now, the basic point made by Hempton is, as far as I can see, the following;

There is a time honoured way of hiding losses in banking – a method that Variant Perception suggests is being done on a breathtaking scale in Spain.  The method is rather than call a bad loan bad – to just extend it a bit more credit.  If the borrower can’t pay the interest give them a bigger loan or line of credit.  They will use the loan to become current. The slogan is that a “rolling loan gathers no loss”.  Even the most diabolical subprime mortgage book in the US showed only small losses until the market stopped rolling the loans.

Together with this qualifying comment at the end;

All these problems of the same type that Variant Perception alleges in Spain – but none are of the scale Variant Perception alleges in Spain.  In other words I can unequivocally support the notion that the Spanish banks are hiding their losses – but support for the notion that these losses are so large that France and Germany will be left “holding the bag” is not to be found in the US data.

What the Spanish bankers have been telling us about their credit is – at least on the American data – easily shown to be lies.  We just don’t know whether they are big lies.

For the sake of Europe I hope they are not.

This last point is naturally important and somehow goes to the heart of the problem at hand here. Are we dealing with one, or a few, rotten apples or is the whole plantation sour? At this point, we can only speculate on the basis of the facts that are on the table. For me personally, it is thoroughly outside my realm of analytical ability to say whether this is a widespread practice among Spanish banks although the extent to which it is, we should be very worried with respect to the Spanish macroeconomy which is alread, as Edward noted recently, in an exceptionally dire state.

But more importantly, the arrows of causation may run in both directions here. Specifically, (and I may be reading too much into Hempton’s analysis here but still), one important underlying current seems to be that with the absolute horrific situation in which the Spanish economy finds itself we should be seeing a lot more pain in the banking sector in the form of loan writedowns or simply deleveraging. And of course, the extent to which we aren’t suggests that Spanish banks are trying to frontload their inevitable losses and the further this goes on the more grim it will be when the penny drops. This, I should add, has been my colleague’s Edward Hugh’s point (and to some extent my own too) right back from the summer of 2007 when it became clear that the subprime crisis was not merely a US undertaking. Basically, better rattle the closet well and good in the beginning and face all the skeletons than have a bunch of them come knocking you out later on, when you have grown, potentially, complacent.

To finish off with my own, albeit modest, contribution to the discussion it is worthwhile taking a look at the chart I have prepared from ECB data on the aggregate balance sheets of monetary financial institutions in France and Spain, where the former is naturally present as a benchmark case.

Essentially the graph plots of a moving average of a weighted value [1] of loans to housholds, loans to non-financial corporations and loans for household purchases in France and Spain (stock value, end of period). The change is month on month and then smoothed with a 6 month moving average. On the basis of the my remarks above the hypothesis to test here would be the extent to which Spain has clearly had a larger boom and subsequent bust than France, the degree and pace of deleveraging should also be comparatively larger and faster in Spain. Clearly, and even though the process of deleveraging in Spain is moving faster than in France, it does not correspond to the macroeconomic differences between the two economies. Could then be evidence of a macroeconomic pendant to practices shown by Hempton to prevail at BBVA? This is to say, is the apparent lack of fastpaced deleveraging in Spain evidence by contraposition to the argument Hempton implies in his analysis?

This is difficult to say and clearly this is no smoking gun since we cannot see beyond, well, what we cannot see and thus Spain may just be about to hit sh’t in the second half of 2009. Also, a larger sample size would aid the hypothesis significnatly, but it does at least makes me think that there may be more to this than meets the eye.

—

[1] I constructed this myself and it is NOT complicated. Mail me if you really want to know what I did.



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A Bull in a Silver Shop

By Richard Daughty, on October 6th, 2009

One of the most interesting news items I’ve found was on the cover of The Financial Times, where I learned that a guy named Lahde “made tens of millions of dollars from betting against the financial and property sectors during [the] past two years”, and he now wanted to thank “the low hanging fruit, i.e. idiots whose parents paid for prep school, Yale, and then the Harvard MBA” who made it all possible for him to find enough suckers.

He noted that “These people who were often truly not worthy of the education they received (or supposedly received) rose to the top of companies such as AIG, Bear Stearns and Lehman Brothers and all levels of our government. All of this behavior supporting the aristocracy,” he says, “only ended up making it easier for me to find people stupid enough to take the other side of my trades. God bless America.”

This goes along with an article in the St. Petersburg Times about Tom James, chairman and chief executive of Raymond, James Financial, who had “some tough words for the wizards of Washington, DC who oversaw the $700-billion bailout package”.

He reports, “The Brave And Wonderful Mogambo (BAWM) was right all along! Those government weenies are the biggest freaking morons you ever saw, and we as a country should be ashamed of ourselves for having elected such corrupt, half-witted, utter failures and congenital idiots!”

As you have probably guessed by now, he did not say those exact words, but he implied every syllable when he said, “Legislators were almost embarrassingly ignorant of how the financial system works”, which I figure explains how they don’t understand the linkage between their own Bad, Bad Performance (BBP) as legislators and the subsequent Bad, Bad Performance (BBP) of the economy, and he says that only 3 of 16 legislators that he talked to actually understood what was going on in the “credit crisis.” Less than 20%! Hahaha! We’re doomed!

Well, maybe these Congressional losers will understand the unfolding economic slowdown, as evidenced by the Baltic Dry Index, which is an index of the cost to transport stuff by cargo ship, and which has fallen precipitously, which seems very important to me, and to Junior Mogambo Ranger (JMR) Riccardo, too, who is also alarmed by this like – as I previously said – me.

It’s actually beyond scary, in a terrifying kind of “ain’t nobody buying nothing in a consumer economy” kind of way, which means that without the consumer buying stuff as his or her contribution to the famous statistic of “the consumer is 70% of the economy”, we are, in case you ain’t heard, freaking doomed!

Well, maybe not all buying is drying up, as silver market analyst, Ted Butler, reports that in the last 10 months, “some 150 million ounces of silver can easily be documented to have been bought by investors. Undocumented purchases would add tens of millions more ounces.”

In fact, when you add it all up, “Investment demand for silver this year is running at a full 25% of world mine production and over 20% of total production (including recycling). This is a remarkable historical turnabout.”

Thus, it is easy to see why Mr. Butler is “bullish beyond belief for silver”, since this kind of demand means that “In silver, the documented 150 million ounces bought in the first ten months of this year is equal to 15% of all the silver bullion equivalent thought to exist!” Wow!

More than one-seventh of all the silver bullion “thought to exist” in the whole world was suddenly bought up in less than a year, and yet the price of silver has been pounded down to less than 10 bucks an ounce? No wonder I am so bullish on silver!

He also notes that the gold/silver ratio is at more than 80, which is “one of the biggest differences in history.”

And not only that, but since there are 4 to 5 billion ounces of gold in the world versus only 1 billion ounces of silver, that means that “the total dollar value of all the gold in the world is worth 300 to 400 times more than all the silver in the world (80 times 4 or 5)”.

Talk about undervalued! Hey! This investing stuff is easy! Whee!



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2009 Economics Nobel Prize

By Ajay Shah, on October 6th, 2009

We’ll soon get the announcement. Here are a few possibilities, computed by Thomson/Reuters, using citation analysis.

If I had to vote, it would be a Taylor/Woodford prize.  For a sense of this work, see: link, link. While inflation targeting was invented in New Zealand based on the intuition of cleanliness in public administration, Taylor and Woodford had a lot to do with being able to think straight about it.

It’s interesting to wonder how publicly visible citation data can be used to predict the Nobel prize outcome. One would want some kind of model which consumes citation data and comes up with an estimate of the Pr(Nobel prize). E.g. if one strong idea suffices (example: James Heckman) then it suggests certain people who will get through (example: Paul Romer). If they want you to build a broad literature (example: Robert Lucas) then that yields a different profile of those who will get through. Hmm, I can’t come up with an example of another Robert Lucas. Such a modelling effort will yield insights on the usefulness of summary statistics of citation data such as the h-index and the g-index. As an example, it’s easy to test which of the h index or the g index have superior predictive power in a model of predicting the Nobel prize.

Most people in India think of Raghuram Rajan as being the first Indian-born economist who became the chief economist of the IMF. What is not widely appreciated is that in the class of economists of Indian origin who are younger than Amartya Sen, Raghu is the best set of papers, as measured by citations.



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