ETFs Are Hammering Silver, Gold Could Be Next

Many factors have been mentioned as contributing to the perfect storm sell off in silver (and commodities in general), but there is one that I haven't heard mentioned yet: A large share of the blame may belong to SLV, the largest silver ETF.

As I have written about previously in "The Real Reason for Silver's Run," much of the run in silver was influenced by increasing retail demand – specifically demand from the SLV ETF and U.S. Silver Eagles, which increased from 12.2mm ounces in the six months ended 9/1/2010 to 66.2mm ounces in the six months ended 3/1/2010 (5.4x in six months).

To see how this has played out, charted below are the holdings of the SLV ETF in ounces vs. the closing price of SLV over the last 12 months.

(Click to enlarge)

On the way up, the ETF demand was welcomed because it moved the silver price up. Unfortunately, that trend has reversed -- as you can clearly see in the graph above. 10% of the holdings of the SLV ETF (36 million ounces) have been arbed out of SLV via the in-kind creation/redemption mechanism and sold at spot since April 25th. To put that in perspective, that is more than ALL of the silver that was arbed in to the trust by the in-kind creation/redemption mechanism since the middle of October -- and more silver than the U.S. minted as Silver Eagles during all of 2010.

While the sales of silver from the ETF were one of MANY factors contributing to the decline, they certainly didn't help the situation ... and have most certainly added to the downward pressure. Whether or not this continues is any ones guess. But what I'd be thinking very hard about is: What is next?

If flows out of SLV added to the silver carnage, the same thing can happen with the gold ETFs -- they have the same in-kind creation/redemption mechanism that keeps the price of the shares tracking spot so closely. If you own GLD, I'd be thinking very hard about selling or hedging the position with puts … 11 tons of gold came out yesterday. If gold ETF fund flows reverse like they did with SLV, then gold could be next.

Disclosure: I am long puts on GLD and SLV.