Sprott’s Silver Call To Arms

December 02, 2011

Anytime Eric Sprott or anyone with a vested interest in a specific asset opines about that asset, his or her words should be taken with a grain of salt.

But as long as we're talking about Eric Sprott, anything he says should be taken with a spoonful. After all, the man runs physically backed gold and silver ETFs with billions in assets and multiple funds which are bullish on both metals.

That said, Sprott's latest missive—a call to arms aimed at the largest silver producers in the world—is a must-read for anyone interested in the price of silver or companies that mine the metal.

His predictions about silver prices and potential government intervention in the market—above and beyond the CME margin hikes already instituted—are, of course, inherently biased. His impact on the market is unmistakable. He obviously wants to influence prices upwardly, and he probably has the influence to do so, but that doesn't mean he'll succeed.

With this in mind, there are some interesting takeaways from his piece that could impact ETF portfolios dramatically. The first is his assertion that silver producers, in a way some have described as similar to what the Saudis have done with oil, start stockpiling silver production as opposed to selling it.

"If the largest pure play silver producers simply adopted the practice of holding 25% of their 2011 cash reserves in physical silver, they would account for almost 10% of that US$9 billion. If this practice we're applied to the expected 2012 free cash flow of the same companies, the proportion of investable silver taken out of circulation could potentially be enormous," wrote Sprott.

While it remains to be seen how responsive silver mining firms will be to his proposal, the potential impact for ETF investors could be twofold.

First, those owning silver commodity ETFs like Sprott's Physical Silver Trust ETV (NYSEArca: PSLV) or the iShares Silver Trust (NYSEArca: SLV) would likely benefit from the diminished supply's impact on market prices.

Furthermore, investors in the Global X Silver Miners ETF (NYSEArca: SIL) would benefit both from the increased revenues realized by silver mining companies selling production at higher prices and the increased enterprise value from the replacement of cash with physical silver, which, hypothetically, would be rising in price.

In other words, companies that mine the most silver become the most attractive targets in this scenario, as their cash flows and assets would increase concurrently, and at a high velocity. Pure-play companies like Silver Wheaton (NYSE: SLW), Coeur d'Alene (NYSE: CDE) and Silver Standard Resources (NasdaqGS: SSRI) immediately jump to mind.

Guess who is one of the biggest investors in these companies?


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