Market Facts: Trading Silver

There was once a time, after the Great Depression but before Watergate, when silver served as the investment vehicle of choice for anyone certain of the onset of economic doom. Prior to 1974, it was illegal for Americans to own gold (unless it came in the form of art, jewelry or dental hardware), so the white metal became a hoarder’s haven, the de facto Armageddon hedge. “People who think the world is coming to an end absolutely love silver,” explains Paul Brittain of Alaron Trading in Las Vegas, who has been buying and selling silver futures and options since 1983 —the same year, as it happens, that the ABC television movie The Day After brought nuclear war into almost every living room in the country.Beyond doomsday survivalists, silver’s glint has captured the eye of housewives and hedge-fund managers alike. And no one, of course, loved the metal more than the Hunt brothers, whose attempt to corner the market in the late 1970s was a legendary debacle.

Just like the Hunts, the hedge funds rushing headlong into electronic silver contracts are attracted by the metal’s role as a monetary underpinning — not by supply-and-demand imbalances between chain makers and tough guys from Brooklyn. Silver is a store of value — like gold, it will always be worth something.

Add to this equation the increasing industrial use of silver, and you start to settle on a seductive investment thesis, particularly in these spooky markets. But while the dark clouds hanging over the global financial system may indeed sport a silver lining, getting even a tiny taste of it could cost you your tongue. Silver is dangerously unpredictable, its volatility downright deadly.

“Silver is the natural gas of the metals market,” explains one COMEX local. “You have vacuum sweeps in silver. Even on the screen sometimes it’ll be quiet, and then it’ll pop 20 cents on nothing.” Brittain agrees: “When the market rallies, it can take you on a ride you aren’t ready for. You sell and it runs a dollar higher, then drops two bucks, then runs a dollar higher again.”

In addition to an active cash market, silver futures trade all over the world, reflecting its truly global nature. Active contracts are traded on the COMEX division of the New York Mercantile Exchange, along with the Chicago Board of Trade (now part of the CME Group), the Tokyo Commodity Exchange, the Dubai Gold & Commodities Exchange and the Multi-Commodity and National Commodity & Derivatives Exchanges of India.

The COMEX silver contract, which has been trading since 1963, is still considered the metal’s principal price-discovery mechanism. The contract is for 5,000 troy ounces of silver delivered physically to an exchange-approved warehouse in 1,000- or 1,100-ounce cast bars bearing a serial number and identifying stamp of an exchange-approved metal refiner. Trading is done on both an open-outcry basis from 8:25 a.m. to 1:25 p.m. EST and virtually around the clock on the CME Group’s Globex trading system Sunday through Friday.

Options trade at 50-cent strikes with a $0.001, or $5, tick size. While futures are available for the first three serial months, the principal trading months for silver are March, May, July, September and December. Futures trade for January, March, May and September for the first 23 months — and, for July and December, for the first 60 months. The tick size is $0.005, or $25. So if you buy one COMEX silver future at $11.50 and sell it at $12, you’ve made $2,500, less commissions. The initial margin for a speculator at press time was $4,050 per contract; hedger and maintenance margins are $3,000 per contract. Like other commodities futures, margins are often changed to reflect shifts in the commodity’s underlying volatility. Explains one bulge-bracket metals trader: “Silver trades at such extremes. When the world gets excited about silver, it’s like trying to catch a flying piano.”

While COMEX is still the world’s home for silver futures, the metals pits are no longer the center of action they were in the ’70s and ’80s. On a full day, they might be home to some 30 locals in silver — down considerably from decades past.

And those guys in the pits now carry handheld computers. “Half of them are trading crude or the S&P 500,” the local says. “If an order comes in, they’ll give you an open-outcry quote, but in the meantime, they’re scalping crude or nat gas.”

“Some guys try to scalp between the screen and what’s coming into the pit,” the local adds. “But that’s getting harder to do, because there’s just less business coming into the pit.”

Much of that screen-based competition has come from the CBOT, which early in this decade launched two silver contracts, a 5,000-ounce open-outcry contract and a 1,000-ounce “mini” traded on the e-CBOT platform. “The Board of Trade is picking up a lot of business, mostly because of the transparency and ease of fill,” Brittain says. “I’ve been using the same floor broker in New York since 1989, but I can get trades done cheaper and faster in Chicago.”

In addition, exchange-traded funds now track silver prices and enable individual investors to trade the metal without a commodities account. Two trade in London: the ETFS Physical Silver Fund (PHAG), which tracks bullion prices, and the ETFS Silver Fund (SLVR), which tracks the Dow Jones–AIG Silver Sub-Index. The ZKB Silver ETF (ZSIL) is domiciled in Switzerland, while in the U.S., the iShares Silver Trust (SLV) commands plenty of volume (almost 400,000 shares a day) and, as of summer 2007, more than 141.6 million ounces of silver — a substantial 15.5 percent of 2006 world production.

For this reason, the Silver Users Association opposed the creation of the iShares Silver Trust. Anticipation of silver sequestration contributed to a jump in silver bullion prices from just over $6.80 per ounce at the end of September 2005 to around $13.70 per ounce in April 2006, the Fund’s launch date. SLV has been a huge success.

“The silver ETFs have made the market a lot choppier,” Brittain explains. “These funds are moving incredible money — money that wouldn’t normally come into silver. A lot of these funds are blowing the tops off lots of markets. The money managers come from equities, and they’re ‘buy! buy! buy!’ guys — they’ll keep buying and push the market one way. And when they dump, they all bail out at the same time.”

In these tumultuous days, there’s certainly no shortage of silver bulls. when metals start to run, a deluge of big silver trades always hits. But anyone looking to catch the silver bullet should take heed: You can make so much money so quickly in silver