THE BLOG
06/08/2011 11:07 am ET Updated Aug 08, 2011

The Silver Scam: How Wall Street Plans to Control Commodity Prices

Silver and BlackRock's silver ETF, iShares Silver Trust ETF (SLV), have been the target of some wild rumors in the past several months.

The crazy stories have run the gamut around the financial blogosphere. One has JPMorgan (JPM) as a puppet of the Federal Reserve, establishing a huge proprietary short in silver designed to pressure the dollar and reduce costs of monetary easing.

Others have BlackRock (BLK) unable to satisfy its share demand with real silver stockpiles. Many claim that legitimate storage for the metal doesn't come anywhere near the almost 11,400 tons of physical silver that the trust reported holding at its extremes in late April of this year.

I don't need to go anywhere near these rumors. The facts about the SLV scam are enough to make a great case for the manipulating effects of the ETF on the price of silver and the model that Wall Street is developing to hold us all hostage on the prices charged for basic commodities that we all need to survive.

Let's have a quick look at the mechanics of this relatively new ETF and how it positively affects silver prices. The SLV looks to represent shares with real physical silver, not derivatives nor stocks of silver miners. The mechanism of connecting shares of the trust to the price of real silver is relatively simple.

As investor interest increases, sending shares of the trust higher, BlackRock continues to issue more shares, using that extra cash to buy and stockpile physical silver ingots. The speed with which they will issue shares and increase their physical holdings is dependent solely on how fast the differential moves between the actual price of physically traded silver and the SLV's share price.

In fund-speak, this is called tracking the net asset value, or NAV, of the fund. If the NAV tracks too high to spot prices, shares go out to satisfy demand for the fund.

And appetites for the SLV have been stunning. Since inception in 2006 and initial stockpiling of 650 tons, the SLV reached its 11,400-ton peak just more than a month ago, an amount that represents almost half of all the silver being globally mined in a single year. Of course this institutional hording system was a tremendous added influence to the price of silver, which recently peaked at over $48 an ounce on April 29.

But what about the last month? With silver's price losing more than $10 an ounce, shouldn't the SLV be working in reverse? If shares are normally issued as appetite for silver increases, shouldn't the number of shares and the stockpiled amount of silver decrease as the retail and institutional investor sell out?

It should and it is, but only to a certain degree. The mechanism of the SLV implies that the fund would never need to sell any of its physical holdings, as long as the cash price keeps up with the share price -- or to put it in fund-speak again, if the NAV doesn't become too discounted.

So as long as appetite for the fund keeps relatively steady even as silver prices decline, the trust can continue to hold the enormous tonnage they've accumulated. That's good for long-term holders and the managers, of course, because silver prices are buoyed as horded stockpiles increase.

Recently, though, retail and institutional appetite did take a dip, but as silver prices swooned, other buyers have come in to take up much of the slack of the share selling that came with it.

But who were those buyers? Conspiracy advocates around the blogosphere won't be surprised to learn it's been the investment banks and trust managers themselves -- the sales force of the fund.

As evidenced by the 13-F Edgar filings, the four largest holders of the SLV have now shifted hands from large institutional funds and into the hands of Bank of America (BAC), Morgan Stanley (MS), JPMorgan and Blackrock themselves.

Besides using cheap funds from the discount window to make these purchases courtesy of Uncle Sam, they also manage to do much of their buying at a discount to NAV, in essence grabbing an immediate advantage compared to spot metal prices. It's become a tidy game.

And as retail and institutional interest in silver comes back, these banks and investment firms are well-placed to resell their accumulated shares at their leisure, above NAV and directly through their own sales teams inside their supposed Chinese walls.

It might sound shady, but it's all entirely legal.

The bottom line for the retail investor is that the trust managers and bank sales teams now have organic support from the proprietary desks at their own investment banks -- and can almost assure that silver won't get decimated in a deeper commodity pullback.

It is also true that silver is a miniscule market, and even tiny further interest generated by those sales teams will result in further spiking of prices, despite silver's already lofty numbers.

Next up in this shady game is copper - both JPMorgan and Blackrock are approved to roll out similar copper ETF's using the same hoarding model this year -- and hype prices on an even more important industrial metal. This game has only begun.