Trading Gold for Silver

by: David Morgan August 28, 2008 | about stocks: SLV    

David Morgan

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In economics and finance, arbitrage is the practice of taking advantage of a price differential between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices. When used by academics, an arbitrage is a transaction that involves no negative cash flow at any probabilistic or temporal state and a positive cash flow in at least one state; in simple terms, a risk-free profit. An entity such as a bank or brokerage firm that engages in arbitrage is called an arbitrageur. The term is mainly applied to trading in financial instruments, such as bonds, stocks, derivatives, commodities, and currencies. (Source Wikipedia.)

There is without a doubt a price differential between retail silver product such as 100-troy-ounce silver bars and the spot price for silver on the Futures Exchange. In fact, this presents a very good arbitrage opportunity for those willing to take the risk. This is accomplished by selling lots of 1000 troy ounces in 100-ounce bar increments and locking in the 1000-oz. Comex bars for delivery. This process is achievable and like all arbitrage situations will find some market participants willing to take advantage of this opportunity.

The spread has been sizeable and over time should narrow, thus making this arbitrage successful. To my knowledge there are very few manufacturers of 100-ounce silver bars. Johnson Matthey in Salt Lake City still produces them and the North West Territorial Mint produces 100-oz. bars with the Pan American Silver Hammer logo. Is it difficult to buy 100-oz. silver bars? Absolutely! Are we short of silver? Not necessarily, but most retail precious metals investors at this time wishing to lock in these prices are finding it extremely difficult.

In my view, this presents an opportunity for someone with the ability to secure a source and/or manufacturer of 100-ounce bars, silver rounds (1-oz. medallions), and perhaps 10-oz. silver bars, using 1000 Comex grade bars as the source.

Personally, I took a somewhat different tack, not necessarily an arbitrage, per se, but what I call the ratio spread. See chart below.

We can see from this weekly chart that gold clearly outperformed silver from 1999 until 2003. The gold/silver ratio reached a high near 82 to 1 in early 2003. The trend has been down since then, meaning that silver has outperformed gold from 2003 to present, but not by much.

If we study this chart carefully, we see that silver has very recently jumped far outside the channel formation that I have drawn. To my thinking, this represents an opportunity to trade gold for silver. This is exactly what I did on August 19, 2008. The actual swap took place near the 62 to 1 ratio, and I expect the ratio to fall back into the channel formation and in the years ahead to continue its downward bias. This channel formation can also be used to swap silver back into gold, which is what I plan to do at some point in the future. This certainly is “trading,” but not in the traditional sense; it is physical reality—real metal is being handed across the counter.

Time will tell whether this proves to be a good trade or not, but from my perspective it looks too good to pass up.

In closing, most markets close arbitrage opportunities rather quickly. Therefore, those who wish to take advantage of the opportunity must take action. Will silver be any different? Time will tell...

Disclosure: Long gold and silver from current bottom

 

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This article has 8 comments:

  •  
    Aug 28 08:22 AM
    IMHO it may already be too late. I thought of doing just that...changing my gold for silver, earlier this year, but decided against that. What I did instead was to start stocking up on silver exclusively. At this time, I cannot find silver here in Florida! I have to rely on Ebay...one brick at a time! Forget about the large distributors/brokers, they want your money, but give every indication that actually getting one's silver order may indeed be a daunting task...in this decade!
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  •  
    Aug 28 09:07 AM
    Silver is the investment of the future at this time! But what will it do in the future? Investing in silver bars will give you a holding of tangible assets, but investing in silver certificates could be a better bet. Silver bars takes quite a bit of space to store, not to mention the security risk involved in keeping them safe. This is especially true if you are storing them in your home. If you store them in a safe deposit box at the bank, you will need a very large box to secure them in, or several boxes at what cost per month? Silver certificates or silver coins present a different angle of storing and security. For example, Take the 911 silver certificates from the twin towers by National mint, They have a face value of $20. They are about 31/2 inched by 6 inches in size and about 1/32 inches thick. Thus, quite a few can be stored in the space of one silver bar. The value of a stack of silver certificates is considerably larger than a silver bar. You can store a sizable value of certificates in a safe deposit box in the same space as one silver bar takes up. The resale value will always be the minimum of purchase face value, while silver bars goes up and down with the silver market. Another investment could be silver dollars (coins), especially the Morgan. These coins have not been minted in over 75 years now. If you can find them, they are more valuable because of their limited commodity. Silver coin collector's tend to hang on to them to pass along to their future generations or for emergencies. Silver coins also are worth a considerable amount more than a silver bar space wise. You can store them in a safe deposit box with much more value than a silver bar takes up too. Silver is a very much in demand rare earth mineral. The Aerospace, Dental, Electronics, Automotive, Marine, and many more industries require large amounts of it for their products. Demand out strips the available world supply much like other rare earth minerals. This will only get worse as the earths population increases. Just a thought.
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  •  
    Aug 28 10:17 AM
    Storing 100 oz bars in a bank safe deposit box-
    The 3" x 10" x 22" box will store 20 bars and costs around $45 per year. This is about 0.15% of the stored value (at $15 / oz.).
    Be sure to get a box location in the vault that is not above your waist. These 20 bars weigh 137 pounds, and you don't want to try to lift them up very far. Two people can make this job easier. I am an average size man (not a weight lifter) and can handle these boxes by my self without difficulty. Smaller boxes are easier to handle, but the cost per bar goes up (sorry- no info on this).
    Be sure to get a metal box. A plastic box will break apart when you try to remove it.
    Visit you boxes once a year. You don't need to really look at the contents. You want to appear as an active customer on the log sheets.
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  •  
    Aug 28 10:49 AM
    As farmers bring the last of the summer fruit & Vegs out of the rual areas of West TN, I see a lot of tradeing Vegs for ASEs,90% Silver coins & of course," Gold!! Green Backs do not buy as much as a 1965 Half Dollar, then then the older & better condition coins begin a flurry of haggling! Why just hanging out with these fine Folks,when they are not covered in biz,They talk of old times,remembering working the fields from dawn to night,many had no electic power,nor in door plumbing,and they talk of being prepared,for they saw what their Mothers & Dads sufferd with,but they thought they had it good back then,no body had money,Silver & Gold was scarce,a Penny would buy things back then,they talked of how people will drop a dime & not even bother to bend over to pick it up! Mr J, said when they leave,I walk over & put in my pocket,He said it happens daily,because everyone is in such a hurry,He said so far this season,He & his wife have added to the amount of Silver 10 fold over last year. He said that shows you that times are getting bad,when most of these Silver & Gold Coins, come from love ones that have passed away! They also have told me that they get more from the Famers than what local Coin Shops in bigger cities offer them.! Mr J has a Blue book & Red Book close by,many people get the fruits & Vegs,plus paper money for the Coins they bring to trade! This has been going on in Rual Areas in TN for some time now. I'm sure it happens else where in rual areas!! Mr J said that the Quality & Rarity of some of the Gold Coins,he has gave them advice to get them NGC or PCGS,so these back wood farmers are no fools when it comes to rare coins,& also show people respect, not to Rip them off as so many others would have done!! I believe you could call this a form of swapping Goods & Services for Silver & Gold!! A Win,Win Good Thing!
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  •  
    Aug 28 01:23 PM
    Interesting posts. I wish to respond to some:

    Blonde Lightning: Those National 911 certs are just not worth it. They are merely a money-maker for the National Mint, period. Suggestion: buy 90% silver (dimes, quarters, half dollars minted PRIOR to 1965) This will give you quality silver at as close to spot sliver price...a winner. Silver dollars (Morgans/Peace) have a HIGH premium attached to them, so you're not getting your moneys worth. Finally, don't fret about space...get yourself a safe, a gun safe is ideal for stacking any type of silver, be it bars, rolls of rounds, etc. An excellent gun safe can be gotten for 300-500 bucks and its going to give you SUPERB security at a miniscule price.

    Jeff44: Please read last sentence of above comment. Please DO NOT store your gold/silver in a safety deposit box. It will be the FIRST to be RANSACKED by the BANK should ever a RECALL of gold reoccur...Remember history?????

    A safe will protect your investment. Experts say that you should spend between 1 and 5% on security measures for your holdings. Think about it. Is that too much to ask? I think not. Also, you can bolt the safe to the floor/wall from the inside to eliminate its "mobility". Just a thought. Good luck!
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  •  
    Aug 28 02:04 PM
    It is too late to do this unless u have enough money to be buying 1000 oz comex bars for delivery. I went to my store to crunch the number to see if u can still have the 60-1 ratio. The best i oculd do in the selling gold to buy silver worked out to around a 50.5-1. U loose a lot of value in the trade to the shop, so i choose not to do this and just am buying 100 oz bars like they are going out of style! Def dont store anything of value in a bank vault!
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  •  
    Aug 28 09:20 PM
    If you want physical silver without the storage headaches, I'm talking real silver, NOT some "paper silver" product, have you guys forgotten about GoldMoney ( goldmoney.com )???
    Setting up an account is EASY and so is buying metal. You want/need to hold it yourself? No problem, they'll be glad to send you YOUR SILVER (or gold) if that's what you want. There seems to be NO SHORTAGE there. Their prices are VERY COMPETITIVE!! And I've NEVER had a problem there either. Why make it harder than it has to be??
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  •  
    Aug 29 04:40 PM
    chux08- I've never heard of them but it sounds great. I'll have to do a little more research though.
    What do you guys think about GDX? Gold stocks are at historic lows and I read this article which seemed pretty positive on GDX: www.greenfaucet.com/tr.... I know that some people prefer to hold only physical gold, but I think GDX is a good substitute for GLD.
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