ETF's Are Not A Real Asset!
Christopher Laird
There is news out for a while about a proposed silver ETF. The industrial users of silver have indicated to the SEC that they are concerned that there is not enough available silver for ETF demand. They believe that a silver ETF will raise their cost of silver drastically, or worse, take all the available silver off the market. Silver is used in a great many industrial and commercial processes.
This is not an article about a silver ETF per se. It is an article about what an ETF really is, how much they are proliferating and how bad they are.
An ETF is an exchange traded fund that people buy into, the idea being that the principals of the ETF then would go buy the real material, or assets. In the case of silver, there is barely enough metal available at COMEX and other trading houses to create enough liquidity. We are very near the point where there will simply not be enough silver to keep things liquid, ie supply dries up. Of course the silver speculators would love that, but all of the industrial processes needing it would have to find some way to get the silver they use every day.
There are ETF's coming online for many things now. These funds are supposed to be market participants, but really, they are loaded with liabilities. I have written in the past about my belief that gold ETF's are not worth messing with.
You buy a gold ETF to get out of paper dollars, but the gold ETF is paper too!
Your account is an electronic book entry against the ETF and is only as good as the credibility of the ETF's principals and employees. Furthermore, the laws of the host nation have to be in favor of you,(ie you have to be allowed to have gold in the first place, or there cannot be a real currency crisis, in which case, if an ETF has several hundred tons of gold I guarantee you will never see that gold yourself, but you have merely paid to have it stored so that the government in crisis can buy it from the ETF at a fixed price THEY choose, not you.)
I am concerned about the problems associated with new paper investment vehicles that require more liquidity than the market is able to provide. I suppose that if an ETF is having trouble getting their hands on the physicals, (mere claims on some bullion in someone's vault like Brinks) that they will find analogous ways to get claims on more bullion, not necessarily by buying it but by creating new paper claims against some gold somewhere, if not in a Brinks vault, then some kind of claim on some gold by who knows what method.
You see, the thing recedes. People want to buy gold through an ETF but really they are forgoing what the actual issue of gold is about and that is physical possession of bullion, and not paper claims! If liquidity were to dry up, there will be a great temptation on the part of ETF principals to come up with ways to take new money but somehow create a claim on some gold somewhere, thereby creating yet another layer between you and the gold.
If liquidity were to dry up, then of course the claims an ETF has on some gold or silver will sky rocket in value, but how are they to get more silver or gold, if it becomes hard to get ?(more so for silver). They would have to stop taking new money wouldn't they?
That is just an example of metal ETF's. But there are issues that I have with the structure of an ETF in the first place. They are really speculation vehicles. They are convenient and electronic. They depend on electronic markets, and liquidity. Any paper vehicle can collapse, and should there be bad news (ex REFCO), they get dropping share values, having to sell their assets to cover the redemptions and so on, liquidity dries up and there you go, exactly NOT the kind of situation you are in a hard asset ETF for in the first place!
I have been pondering the effects of all these virtual claims on many kinds of assets. Now the assets do exist somewhere. But how many layers exist between you and the assets? It is not only ETF's. Derivatives are being created that are way over 5 times the total GDP of the world! Now tell me, all that money back of the worlds GDP making claims of every conceivable sort on everything imaginable, from real estate to gold to silver to oil to currencies….means there is really just a gigantic leveraged claim on world GDP of well over 5 times that, and probably ten times that.
First of all, with all these claims on everything we own and use, think about the complexity that is introduced. Take derivatives for example. The Fed and other world central banks have repeatedly stated that, even though they are risky and have grown from about 20 trillion $ in 1990 to well over 250 trillion now, they all agree that it is not possible to regulate this market. They depend on the market makers (derivatives banks, dealers, and counterparties) to self regulate. I think this shows the fact that it is literally impossible to regulate derivatives, there being so many different ways to create one, that it is just a simple academic fact that the whole leveraged mess will explode, given the fact that man is imperfect at best, and dishonest at worst.
Now let us return to an ETF. Given the fact that these are really paper promises from an ETF to you, the investor, you realize of course that you are depending totally on their integrity, solubility, and market liquidity, that the physical assets you think you are buying are actually there where you think it is. AND if you want to ever get it back, I predict the best way to redeem it will be again, in dollars, and not in that asset in kind.
Like taking delivery on a COMEX contract.
But you think that you are owning a real thing.
An ETF is regulated by the laws of the land. Laws change. What you buy into today may be completely different from what you are owning tomorrow, basically depending on the financial stability of the Nation in question, and at the whim of the legislators or the President, who can change anything and have changed everything in times of great crisis.
But you bought that ETF claim, based on some kind of economy that was working when you bought in, a financial system that was working at the beginning, and later, a national currency crisis, banking crisis, market liquidity crisis, or another crisis changes everything, and now all the laws are subject to change, and the best outcome for the ETF would be probably payment in…. you guessed it… in dollars.
But you thought you owned a real asset, didn't you?
I have another basic objection to an ETF. It is a multilayered paper/electronic claim. There are layers and layers you have to go through to get anything back. You have layers of laws between you and the asset you think you own. Let me tell you something. Having a claim on something, and actually getting it are two different things……
To me, there is no comparison whatsoever with a gold coin and a paper claim on it. One is in your hand with nothing between you and it. The other is subject to all the uncertainties I outlined above, and many more that I haven't even outlined. If the asset is not in your actual hand, any and all unpredictable events are between you and it! Many uncertainties I know, and many I don't know about, uncertainties between me and that asset, through an ETF vehicle that is just a paper statement. This creates a universe of unknowns between me and the asset I think I have a claim on, whereas, with a gold coin, after I assay it, I know what I have. There is no comparison whatsoever between a real asset in my hand and a claim on that asset.
But, people treat asset based ETF's as if they had actually the asset in hand. But this is just not a reality, is it? But the talk about these things, ETF's are as if they were real analogs to the asset in the first place. But they most certainly are not as good as gold!
Does that make sense?
I have been discussing issues like ETF's for a while now in the PrudentSquirrel newsletter. My subscribers hear about this and other matters such as general economic trends that affect gold and investments. I do a lot of fundamental analysis in the newsletter. It is not the common material you read. I read over 200 articles a week in researching for my weekly issue of the letter. I do not do chart analysis. The newsletter is 100 percent fact and event driven. Everything that is presented is accompanied by news, facts and logic. You may not find this too often, as some focus almost entirely on chart analysis, and if there is any fundamental analysis there, it is as an aside.
Stop by and read the testimonials and subscribe. It is a great value at 44$ for six months, or 88$ for a year. My cancellation rate is virtually zero.
Christopher Laird
Editor-in Chief
The PrudentSquirrel Newsletter
www.PrudentSquirrel.com
By the way, the site has been up for 6 months only and I have well over 4 million hits already! My web master says that Google and other rating sites say the site is very very popular… I have lots of plans for the Newsletter and it is going just great as far as I am concerned. Also, those books I have been talking about are still in the works, I hope to have one of them ready in several months.
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