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The Fed And SLV – What’s Ahead?

Summary The FOMC is expected to raise rates this week. How will this decision impact SLV? Whether the Fed raises rates or not, isn’t the only issue to consider. The FOMC is expected to convene this week and decide whether it’s time to hit lift off and raise rates. While rates are still expected to remain low, even a modest hike of 0.25 basis points could be enough to send down the iShares Silver Trust ETF (NYSEARCA: SLV ). But the direction of the silver market won’t only rely on the whether the Fed raises rates or not. Other considerations also matter including what’s the trajectory of the future rate hikes, the wording of the statement, the revised outlook for next year, and Chair Yellen’s press conference just to name a few. How will the Fed expected hike move the price of SLV? Let’s breakdown what’s up ahead for SLV. Based on the implied probabilities , the market expects three rate hikes in 2015-2016 with a very likely hike in December – a little over 80% chance, the highest level in months. But with an 80% chance this still gives some room for uncertainty in the markets. (click to enlarge) Source: Fed-watch If the Fed does move along with the hike, it’s likely to bring down the price of SLV as it did back in the last FOMC meeting when the Fed stated it’s ready to raise rates in December. Is the market ready for a hike? When it comes to the reasoning for raising rates the Fed sees that the U.S. labor market is on course to full employment with unemployment rate at 5%, an average of over 200,000 jobs were added a monthly basis in 2015 and wage growth at 2.3%. Also, U.S. core CPI is at 1.9%, which isn’t far off the Fed’s 2% target . And the Case-Shiller home price index showed that prices have been steadily climbing in the past three years; while prices aren’t at record high levels of mid-2006, they are still high enough to sustain a rise in mortgage rates and weed out any possible bubbles that may be forming in the real estate market. The same could be said about the stock market. The flip side for keeping rates unchanged is that the labor market may not be in a good enough shape to sustain higher rates with “real unemployment rate” or U6 rate is close to 10% and participation rate remains low. Moreover, the expected rising cash rates will make it even harder for the Fed to reach its 2% inflation goal. And low commodities prices aren’t helping. Having said that, the Fed is still expected to raise rates this meeting. And higher rates won’t do any good for SLV. From the perceptive of the stronger U.S. dollar, a stronger dollar could push down SLV. After all, the rally of the U.S. dollar in recent weeks, up to the last couple of weeks, seemed to have contributed to the weakness of SLV, as indicated in the chart below. (click to enlarge) Source: FRED and Google finance Bear in mind, however, that the correlation between the two isn’t too strong at -0.26 during 2015. But the correlation has intensified lately: Over the past couple of months it reached -0.4. So keep an eye out for the direction of U.S. dollar, which is likely to keep rising if the Fed moves on with normalization. Beyond this time’s rate hike Looking beyond the expected rate hike, the Fed is likely to issue a statement with a dovish tone reiterating that future hikes won’t be every other meeting and will spread apart in 2016 – something that will be backed by the dot plot. Chair Yellen will also try to calm the markets by assuring the strength and stability of the U.S. economy and how another hike won’t be decided any time soon (the term “data dependent” will be thrown a lot – as it always is). The FOMC will also release its dot plot about the cash rate. Back in September, the FOMC anticipated rates will rise to 1.4% by the end of next year and 2.6% by the end of 2017. The trajectory of the cash rate could also have an impact on the direction of the price of SLV. On this issue, if the FOMC were to revise down its outlook about the cash rates, and it’s a very likely scenario, this could partly offset the adverse impact the rate hike in the upcoming meeting will have on precious metals prices. This could translate to keeping SLV from tumbling down in the coming months. Unless the Fed surprises the market, the short term outlook of SLV is still likely to be downward. The expected rise in the U.S. dollar could keep driving down SLV. On the other hand, if the Fed cuts down again its outlook for the cash rate in 2016 and beyond, this could, down the line, keep the price of SLV from further plunging in the medium term. For more please see: Will Higher Physical Demand for Silver Drive Up SLV?

SLVO: A Safer Way To Invest In Silver

Summary SLVO is an ETN issued by Credit Suisse, benchmarked to the Credit Suisse NASDAQ SilverFLOWSTM 106 Index, a proprietary index designed to track a covered call strategy. The Credit Suisse NASDAQ Silver FLOWSTM 106 Index notionally sells approximately 6% out of the money notional calls each month while maintaining a notional long position in SLV shares. The exchange traded note can potentially lower the downside risk over owning SLV shares outright with the approximately 14% distribution representing the covered call premiums. Unlike in the world of stock and bond investors, the precious metals world has a wide variety of investors, ranging from individuals and institutions who just want to have precious metals exposures, to bullion purists who believe the only “real” way to invest in precious metals is to buy bullion that you hold in your hands, in your safe. This investment… is not for them. This ETN is for someone who would currently invest in silver via an ETF like the iShares Silver Trust ETF (NYSEARCA: SLV ) or the Sprott Physical Silver Trust (NYSEARCA: PSLV ) or a silver mining stock and just wants a bit more income. What Is the Credit Suisse Silver Shares Covered Call ETN (NASDAQ: SLVO )? SLVO is an exchange traded note benchmarked to the Credit Suisse NASDAQ Silver FLOWSTM 106 Index. The index is designed to replicate a strategy where you would write short term options against shares of SLV, the silver ETF. Specifically, Credit Suisse describes the index as follows: The Index was created by Credit Suisse and is published and calculated by NASDAQ OMX. Call options with approximately 40 days to expiry are sold over a 5-day period each month within the Index. Approximately 30 days later, those same call options are repurchased over a 5-day period. The notional premium received, net of notional transaction costs, is paid out following the repurchase of the options on or about the 25th of the month. Source: Credit Suisse Below is a graphical representation of the Index. The Index and ETN were launched approximately 2 years ago, on April 16, 2013. The ETN charges a .65% annual fee. Performance Anyone who has invested in precious metals over the last 5 years, has most likely either lost money, or is sitting on paper losses. Over the last 5 years, investments in silver have lost approximately 22%. If you were unfortunate enough to buy silver at the peaks in 2011, you would have lost more than 60% of your investment value. There are a variety of reasons for the meteoric rise and fall for silver which are not the focus of this article, however I implore you to read an article I recently published dealing with this exact issue here. “Why $8 Silver is Just as Likely.” Theoretically, a covered call strategy will be able to generate more income and outperform a simple buy and hold strategy in falling and flat markets. In order to generate the incremental income, you are giving up your upside over the strike price of the call options. In more volatile markets, writing call options generally makes sense as you are able to monetize the risk you are already taking by holding the underlying investment. Where you end up losing is during rising markets and your investments are called. This is exactly what happened if you held over from inception of the fund. You can see that below. If you invested $10,000 in each, SLV and SLVO at SLVO’s inception, your SLV holding would be worth $6,212 and your SLVO holding would be worth $5,541. The underpformance would come from the few sharp rebound spikes silver went through in the fairly aggressive declines of 2013 where SLVO would pay more to buy back the calls. (click to enlarge) In a more orderly selloff as we had seen over the last year, the numbers look different, and the covered call strategy saved you some losses, particularly as you would purchase back, or let the covered calls expire worthless. If you purchased and held SLV 1 year ago, your $10,000 would be worth $7,191 today. An SLVO investment of that same $10,000 would be worth $7,306. Had you taken your distribution in cash and not reinvested it, I suspect that number would be slightly higher as your reinvestments were worth less today, at the lows of the year. (click to enlarge) So… Is this right for you? Perhaps. If you want to be invested in silver, and would not mind giving up a bit of upside in order to monetize the risk and receive income, you should consider this ETN. The strategy makes sense and the annual expense of .65% is certainly not outrageous, especially if you consider the transaction costs you would incur if you wrote covered calls on your own month in and month out, both selling to open and buying to close. The potential downside here and something that we did not discuss is the product structure. This is an ETN, an exchange traded note, and not an ETF, an exchange traded fund. Unlike an ETF, ETNs are not shares of the actual underlying funds, ETNs are credit obligations, like bonds of the underlying issuer, whose value tracks a specified index. In the event of a default, owners of the ETN would be lining up for the settlement in the liquidation of the issuer. While Credit Suisse is a sound institution, at least today, this is an additional credit risk that you should take into account. If you are not comfortable with taking on additional credit risk, you can consider other covered called strategies such as the GAMCO Global Gold, Natural Resources & Income Trust (NYSEMKT: GGN ) and the BlackRock Resources & Commodities Strategy Trust (NYSE: BCX ). For more discussion about risk faced with ETN investing, feel free to read my previous ETN articles such as RBS ETNS: When A Good Idea Alone is Not Enough . Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: None of the information discussed should be considered investment advice or a solicitation to buy or sell any securities. Please consult your investment advisor for specific recommendations.

Will China Pull Back Up SLV?

China’s possible economic slowdown may have contributed to the recent fall in the price of SLV. China’s demand for silver is expected to grow this year in part due to an increase in installation of solar panels. The physical demand for silver is less likely to impact the price of SLV. While all eyes are set towards the Greek debt crisis, the price of the iShares Silver Trust ETF (NYSEARCA: SLV ) has come down in the past few weeks. Some attributed the fall in prices , in part, to fears of an economic slowdown in China. Nonetheless, China’s demand for silver is still expected to rise this year. But will China pull up the price of SLV? As I have pointed out in the past, the physical demand for silver, while plays an important role in moving the price of silver, is still only secondary to the changes in the demand for silver for investment purposes. The same goes for China’s growing demand for silver. One of the main growing industries in China where the demand for silver has increased is in the photovoltaic business, i.e. the installation of solar panels. So far this year, China was able to ramp up its installation capacity – it reached 5.04 GW in the first quarter. This year, China set a high target of installing a total of 17.8 GW of solar PV. If so, this will account for nearly a third of the global solar PV installations for 2015. How much silver is needed to reach this 17.8 GW goal? According to PV-Tech , it takes nearly 80 tons of silver, or 2.8 million ounces of silver, to generate one gigawatt of electricity from solar. Considering China aims to install 17.8 GW, this means it will need around 50 million ounces of silver. On a global scale, with an estimate of 55 GW, the world’s demand for silver in the PV solar industry will be around 154 million ounces – nearly two and a half times the amount of silver consumed in this industry back in 2014; it’s also 14% of total physical demand of silver. Last year , however, this industry accounted for only 5.6% of the physical demand of silver. Moreover, the demand for silver in this industry has gone down since its peak year – 2011. Color me dubious, but I’m a bit skeptic that China will be able to reach such a high target, let alone need to ramp up its solar industry capacity so rapidly especially now that oil prices have gone down. Keep in mind, in previous years, the role of PV solar was small from the total global demand for silver. And China’s demand for silver, while important, hasn’t driven up the price of SLV in the past few years. But even if you do believe China’s demand for silver will rise and its economy isn’t slowing down, it’s still a stretch to consider this turn of events will increase the price of SLV. Thus, it’s less likely that China, even if it does increase its demand for silver, will drive up SLV. I think the drama in Greece, which has raised the uncertainty in the financial markets mainly in forex, and the potential change in the Federal Reverse’s policy in the coming months are likely to lead the way in moving the price of SLV. When it comes to the Fed, even though Yellen keeps promising it will raise rates this year, the market isn’t convinced: According to the bond market, the implied probabilities of a rate hike in September have fallen to only 14% and 50% in December. The minutes of the FOMC meeting revealed that some members still think it could be too soon to raise rates: “Most participants judged that the conditions for policy firming had not yet been achieved; a number of them cautioned against a premature decision.” Other members thought the conditions for a rate hike is plausible in the very near term: “Some participants viewed the economic conditions for increasing the target range for the federal funds rate as having been met or were confident that they would be met shortly. They identified several possible risks associated with delaying the start of policy firming. One such risk was the possibility that the Committee might need to tighten more rapidly than financial markets currently anticipate – an outcome that could be associated with a significant rise in longer-term interest rates or heightened financial market volatility.” The Greek saga could also push the rate hike to 2016 if Greece were to exit the EU; a Grexit could further raise the uncertainty in the financial markets and provide an excuse for the doves in the Federal Reserve to err on the side of caution by keeping rates low until the beginning of 2016 and see how the Greek exit plays out. China is expected to increase its demand for silver and the solar industry will likely to take a bigger role in the physical demand for silver. It’s still possible that China’s demand will grow slower mainly if its economy slows down. But as for the price of SLV, it seems less likely that even a higher growth path for China’s silver consumption will drive up, for extended periods, the price of this precious metal. (For more please see: ” Is SLV about to change course? “). Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.