SPROTT ASSET MANAGEMENT LP

The Double-Barreled Silver Issue

Regular Markets at a Glance readers may have wondered why we remained so silent on the subject of silver over the last several months. Considering the significant exposure we have to silver as a firm, we can assure you that it wasnt for lack of desire to share our views, but rather due to strict solicitation restrictions imposed on us by the cross-border listing of Sprott Physical Silver Trust (PSLV) this past October. It therefore gives us great pleasure to finally share our views on silver with you. We have included two separate articles in this issue of Markets at a Glance: the first was written back in June 2010, and contains the information we used in the prospectus for the PSLV. The second is an update article written this past month that discusses new developments in the silver market and confirms our views on the metal. We urge you to read them both in order to understand our investment thesis for silver, and we hope they compel you to take a much closer look at silver as a long-term investment. Silvers dramatic rise over the last two months is no fluke - its the result of a compelling supply/demand dynamic within a unique market structure. We hope the following articles convey our enthusiasm for the other shiny metal as an exceptional investment opportunity.

June 2010

SPROTT ASSET MANAGEMENT LP

The Silver Lining

By: Eric Sprott & David Franklin

No matter how complex our financial system becomes, the economic axiom of supply and demand will still apply. If the demand for an asset outstrips supply, the price of that asset will appreciate. The challenge in finding supply and demand imbalances in todays market often lies in judging the quality of market data available it frequently isnt even close to being accurate. If the numbers dont show the imbalances, its tough for investors to determine if the market price accurately reflects the market dynamics. Nowhere is this more prevalent than in the market for silver. While gold dominates the headlines, the silver market actually enjoys a superior fundamental supply/ demand story than that for gold, although youd never know it based on the silver demand statistics from the major reporting services. As students of the precious metals markets we monitor the numerous metals reporting services very closely. According to those services, the silver market has enjoyed a stable supply/demand balance for almost ten years now. If thats the case, why has the price of silver appreciated from $5 to $19/oz over that same time period? Is the reporting services data on the silver market truly reflective of silvers underlying fundamentals? Although there are several reporting services for silver market information, GFMS Ltd. and The Silver Institute are the most often quoted sources for silver market data. While they provide statistics for both silver supply and demand, it is their neglect of the investment demand category that we find problematic. GFMS and The Silver Institute use a category called implied net investment to capture the demand for physical silver from institutional and retail investors. The definition for net investment as defined by GFMS is the residual from combining all other GFMS data on silver supply/demand As such, it captures the net physical impact of all transactions not covered by the other supply/ demand variables.1 In other words, it is not an observed figure. GFMSs implied net investment number doesnt include any observable demand for silver by ETFs and other reporting entities such as hedge funds - it is merely a plug used to balance the supply data for GFMSs and the Silver Institutes reporting purposes.2 As we delved deeper into the silver market, this realization prompted us to calculate our own investment demand statistic. We present our findings in Table A. While GFMS and The Silver Institute use an implied number, we calculated a real investment demand number using a handful of ETFs and two other large private investors, one of which is our own firm. Our demand metric is by no means complete or exhaustive we only used seven sources of reported investment demand, and yet from our informal and incomplete survey we found that GFMS and The Silver Institute had underreported silver investment demand by at least 225 million ounces! This shortfall doesnt consider any other investors that may have bought silver over the past year, so real demand for silver could be multiple times higher.
1 World Silver Survey 2009 - A Summary Produced for The Silver Institute by GFMS Limited, Page 5. Retrieved on June 27, 2010 from: http://www.silverinstitute.org/images/stories/silver/PDF/wss09sum.pdf 2 Demand and Supply in 2009 Supply and Demand. The Silver Institute. Retrieved on June 27, 2010 from: http://www.silverinstitute.org/supply_demand.php

June 2010

Table A

Real investment Demand for Silver

Holder
iShares Silver Trust 3 Central Fund of Canada
4 5

Silver Holdings in Oz as of December 31, 2009

305,205,951 67,322,479 59,370,000 41,838,539 23,370,555 20,000,000 2,476,400 519,583,924 293,800,000 225,783,924

Zrcher Kantonalbank (ZKB) Silver ETF Sprott Asset Management 6 ETFS - Silver UK 7 GoldMoney
8

Claymore Silver Bullion Trust 9 TOTAL Holdings Aggregate Implied Investment Demand (2000 to 2009)10 Missing Investment Demand
Source: Sprott Asset Management

Given its seemingly evident market imbalances, you might wonder why silver hasnt performed better over the last year. The answer, we believe, lies in the way silver is priced. The silver spot price is dictated by paper contracts that trade on the COMEX exchange in New York. Paper contracts can be purchased long or sold short. If more participants sell short than purchase long, the paper market price for silver will decline. Often these contracts have little to no relationship with actual physical silver, and yet they are the most influential contract in determining silvers physical spot price. Go figure. In studying the silver market we owe a great debt to the work of silver analyst, Ted Butler. Mr. Butler has been writing about the silver market for fifteen years and has done much to inform investors about the reality of silvers physical fundamentals. Butler provides some insight into the short positions that exist in silver today, highlighting the fact that the eight largest silver traders currently hold a net short position of over 66,000 contracts, representing more than 330 million ounces of silver.11 This means that the eight largest COMEX traders are net short the equivalent of 48.5% of the worlds total annual silver mine production of 680.9 million ounces. None of these traders are in the silver business by the way theyre all financial institutions. In addition, the COMEX silver short position held by the eight largest traders on May 3, 2010, represented 33% of total world silver bullion inventory,

3 iShares Silver Trust NAV History (SLV) Trust Documents Historical Data. iShares Silver Trust (SLV). Retrieved on June 27, 2010 from: http://us.ishares.com/product_info/fund/excel_historicaldetails.htm?ticker=SLV 4 Central Fund of Canada Q1 Interim Report to Shareholders (January 31, 2010). Retrieved on June 27, 2010 from: http://www.centralfund.com/ quarterlyreports/2010%20Quarterly%20Reports/CFOC%20-%201st%20Quarter%20Report%20-%20Feb%2023%202010.pdf 5 Larkin, Nicholas (January 4, 2010) ZKB Silver ETF Holdings Increase to 59.37 Million Ounces Bloomberg 6 Sprott Asset Management LP. Audited Annual Financial Statements. December 31, 2009. Retrieved on June 27, 2010 from: http://www.sprott. com/Docs/FinancialReports/Mgmt_Report/2009/Dec_2009_Financials.pdf. Our silver holdings are inclusive of personal holdings of Directors and management of Sprott Inc. and managed accounts held for individuals. 7 ETF Securities. Copy of the Silver bar count conducted by Inspectorate International Limited for ETFS Metals Securities Limited. (March 19, 2010) Retrieved from: http://www.etfsecurities.com/en/updates/document_pdfs/MSL_Silver_19235.pdf 8 Turk, James. GoldMoney 9 Claymore Silver Bullion Trust (SVR.UN) Annual Report December 31, 2009. Retrieved on June27, 2010 from: http://www.sedar.com/DisplayCompanyDocuments.do?lang=EN&issuerNo=00028552 10 Demand and Supply in 2009 Supply and Demand. The Silver Institute. Retrieved on June 27, 2010 from: http://www.silverinstitute.org/supply_demand.php 11 Butler, Ted. (May 3, 2010) Time is Running Out. Subscriber Only Service

June 2010

estimated by Butler to be approximately one billion ounces. There is no real comparison with gold, as the 24.5 million ounce concentrated net short position held by the eight largest traders represents a mere 1.2% of the 2 billion+ ounces of world gold bullion inventory as reported by the World Gold Council.12 So in comparison to total world bullion inventories, the concentrated short position in silver is 27 times larger than that for gold. In every comparison possible, the short position in COMEX silver contracts is off the charts, and if you think the short positions sound potentially disruptive, youre not alone. In September 2008 the CFTC confirmed that its Division of Enforcement has been investigating complaints of misconduct in the silver market. This investigation is ongoing and we look forward to its resolution.13 Because we believe the demand for precious metals will continue to increase in this environment, were always interested to know the total supply available in todays physical bullion market. According to the best estimates from the USGS and current mining statistics, approximately 46 billion ounces of silver have been mined since the dawn of civilization.14 In comparison, approximately 5 billion ounces of gold have been mined throughout history.15 Reading this, a casual observer might conclude that gold is currently justified in being worth more than silver based on its relative scarcity. But the current price discrepancy ($1,250/oz gold vs $19/oz silver) is misleading. As mentioned above, there are only 1 billion ounces of silver left above ground in bullion form today. That is a surprisingly small number in relation to the 46 billion ounces mined throughout history. The reason is due to silvers consumption in manufacturing. Just like other industrial minerals, silver has been consumed in various processes over the course of history. Silvers superiority in heat transfer, conductivity and light reflectivity make it unique, and it boasts anti-microbial properties that make it ideal for surgical instruments, clothing materials and certain medical applications. The key point to remember with all these applications is that once the silver is consumed it is typically never recycled. Many of its industrial applications require such small amounts in each surgical tool, electronic device or clothing item that it isnt economic to recover from garbage dumps. For comparison, there are currently approximately two billion ounces of gold above ground in bullion form compared with the 5 billion ounces of gold mined throughout history.16 So despite being more heavily mined over time, silver bullion is now the more scarce precious metal than gold bullion is from an investment supply perspective. This is where the silver story gets interesting for us. At todays prices you have $19 billion dollars of silver ($19 x 1 billion ounces) and $2.5 trillion dollars of gold ($1250 x 2 billion ounces) above ground in bullion form. The size of the investment market for gold is therefore 131 times larger than that for silver. And yet, on a market relative dollar basis, investors are actually buying more silver than they are gold today. At todays metals prices, in dollar terms, the US mint has sold approximately three times more value in gold than in silver thus far in 2010 coin sales. But there should be 131 times more gold sold than silver for the market to stay in balance. None of the largest gold and silver investment vehicles reflect the 131:1 ratio, suggesting that investors have a disproportionately large interest in owning physical silver.
12 Retail Gold Investment and Private Investor Stocks - A Review. Prepared for the World Gold Council by Gold Fields Mineral Services Limited (November 2001). Retrieved on June 27, 2010 from: http://www.gold.org/assets/file/pub_archive/pdf/retailgold.pdf 13 US Commodities Futures Trading Commission (October 2, 2008) CFTCs 2008 Fiscal Year Enforcement Roundup: Agency Files 40 Actions, Obtains Record Amount in Penalties and Fines, Discloses Crude Oil Investigation, Forms Forex Task Force Retrieved on June 27, 2010 from: http://www.cftc. gov/PressRoom/PressReleases/pr5562-08.html 14 Total world silver mine production from prehistory through 2001 is estimated by the U.S. Geological Survey (USGS) to have been about 1.26 million metric tons (Mt) 1.26 Mt x 32,150.75 ounces/tonne = 40.51 billion ounces + production since 2001 from The Silver Institute of 5.75 billion oz. Butterman, W.C. and Hilliard, H.E. (2005) MINERAL COMMODITY PROFILES Silver. Open-File Report 2004-1251 U.S. Department of the Interior U.S. Geological Survey. Pg. 4. Retrieved on June 27, 2010 from: http://pubs.usgs.gov/of/2004/1251/2004-1251.pdf. Demand and Supply in 2009 Supply and Demand. The Silver Institute. Retrieved on June 27, 2010 from: http://www.silverinstitute.org/supply_demand.php 15 In all of history, only 161,000 tons of gold have been mined, barely enough to fill two Olympic-size swimming pools. x 32,150.75oz is 5,176,262,700 oz. of gold Larmer, Brook. (January 2009) The Real Price of Gold National Geographic Magazine. Retrieved on June 27, 2010 from: http://ngm.nationalgeographic.com/print/2009/01/gold/larmer-text. Retail Gold Investment and Private Investor Stocks - A Review. Prepared for the World Gold Council by Gold Fields Mineral Services Limited (November 2001). Retrieved on June 27, 2010 from: http://www.gold.org/assets/file/ pub_archive/pdf/retailgold.pdf 16 Retail Gold Investment and Private Investo Stocks - A Review. Prepared for the World Gold Council by Gold Fields Mineral Services Limited (November 2001). Retrieved on June 27, 2010 from: http://www.gold.org/assets/file/pub_archive/pdf/retailgold.pdf.

June 2010

For example, the largest gold ETF today, the SPDR Gold Trust (GLD), is currently ten times the dollar value of the largest silver ETF, the iShares Silver Trust (SLV). Since the SLV began trading in April 2006, the GLD has increased by $8 for every $1 increase in SLVs NAV. Again, given the choice, investors are voting with their dollars and putting disproportionately more dollars into silver than gold from a relative market size perspective. It appears that no investors are anywhere close to buying 131 times more gold than silver, which market metrics would suggest if the demand for gold and silver were relatively equal all of which brings us to silvers supply conundrum: If on the supply side, as Ted Butler calculates, there are only one billion ounces of silver left in bullion form available for investment; and if, on the demand side, we were able to identify the holders of 500 million ounces spread across a mere seven investors - it implies that there is only 500 million ounces of silver left for everyone else to invest in! As large holders of silver bullion ourselves, we can tell you that 500 million ounces is not that much from a global perspective, and certainly wont be enough to satiate the worlds investment demand for silver going forward. Also let us not forget the large silver short position on the COMEX that will almost undoubtedly require the purchase of 330 million ounces of silver to eventually cover. Assuming that happens, most of the silver available for investment will essentially already have been spoken for. It also serves to mention that there will be no government silver stocks capable of covering this impending supply shortfall. According to the latest audit, the US treasury currently has 7,075,171 oz of silver in storage, which is about enough to handle two months of silver eagle coin production. If the COMEX silver short sellers are ever forced to cover, they wont be able to lean on the government for a physical bailout.17 Judging by the numbers above, if hedge funds or any other large investor ever decided to invest in the physical silver market with the same voracity as they did with gold, the silver price could potentially explode. The existing silver inventory at COMEX is currently worth a little more than $2 billion at todays silver price. We already know that high-profile hedge fund managers like Soros, Paulson and Einhorn have gold holdings with a total value of over $5 billion.18 If that same purchasing power was ever applied to the silver market, we could potentially witness a dramatic rise in the silver price and an effective clearing of all the physical silver in the COMEX inventory. It deserves mention that the SPDR Gold Trust (GLD) added almost $5 billion dollars worth of gold in the last month alone, and it would take less than half of that GLD gold investment to wipe out the entire silver COMEX inventory. The bottom line for us is that silver appears to be a fantastic investment today. Limited supply, strong demand and a potential buyer of almost half of one years global mining silver output make a great case for owning silver in physical form. Based on our calculations, it appears that the silver investment demand statistics published by GFMS and The Silver Institute are highly misleading at best. We believe the investment demand for silver is multiple times higher than that published, and given the outrageous short position in silver on the COMEX, coupled with the unsustainable buying ratios relative to gold, the case for physical silver is simply outstanding. As the expression goes, every cloud has a silver lining. Notice it isnt a gold lining or a platinum lining. In the silver market, the cloud has been duly represented by poor estimations of investment demand coupled with large outstanding short positions. That cloud will soon lift, revealing a silver lining that is far more valuable than it is today.

17 Office of Inspector General, Department of the Treasury (October 21, 2009) Audit of the United States Mints Schedule of Custodial Deep Storage Gold and Silver Reserves as of September 30, 2009 and 2008. Retrieved on June 27, 2010 from: http://www.treas.gov/inspector-general/auditreports/2010/oig10003.pdf 18 Bloomberg reported holdings of the SPDR Gold Trust of Soros Fund Management is 5,585,947 shares and Paulson & Co. 31,500,000 shares as of March 31, 2010 at a current price of $122.76 the total value is $4,552,670,854. Greelight Capital held 4.2 million shares of the SPDR Gold Trust at the end of Q1 2009 which would be valued at approximately $500 million.

November 2010

SPROTT ASSET MANAGEMENT LP

All that Glitters is Silver

By: Eric Sprott & David Franklin

In the four months since we filed the prospectus for the Sprott Physical Silver Trust on July 9, 2010, the silver price has rocketed up 54%, bringing its year-to-date return up to a stunning 68% (!!). Silver has now outperformed all of the other eighteen commodity components that comprise the CRB Commodity Price Index on a year-to-date basis. Silver has been the indisputable star of 2010, and we have been very long the physical metal in many of our mutual funds and hedge funds. Silvers performance since June has been influenced by a number of factors. The first and arguably most significant development took place on October 26, 2010 when comments were released by Bart Chilton of the Commodity Futures and Trading Commission (CFTC). The CFTC is the US government agency that supposedly regulates the US futures and options markets. While the CFTC has technically been investigating the silver market since 2008, it had revealed nothing about its findings for over two years. Everything suddenly changed when Mr. Chilton, a CFTC Commissioner no less, publicly stated that, I believe that there have been repeated attempts to influence prices in the silver markets. There have been fraudulent efforts to persuade and deviously control that price. Based on what I have been told by members of the public, and reviewed in publicly available documents, I believe violations to the Commodity Exchange Act (CEA) have taken place in silver markets and that any such violation of the law in this regard should be prosecuted (emphasis ours).1 These comments quickly triggered a flurry of lawsuits against the purported manipulators and set the silver market on fire. There are now no less than four lawsuits seeking class action status. They all allege that JP Morgan Chase & Co. and HSBC Securities Inc. colluded to manipulate the silver futures market beginning in the first half of 2008. The suits claim that the two banks amassed massive short positions in silver futures contracts that they had no intent to fill in order to force silver prices down for their furtive benefit. The suits also describe two crash events that were set in motion by JP Morgan and HSBC, one in March 2008, and the other in February 2010, after the defendants had amassed large short positions. The suits allege that COMEX silver futures prices subsequently collapsed to the benefit of both banks in the wake of these events.2 The fallout from these accusations has undoubtedly increased the investment demand for silver, and it serves to remember, as we highlighted in the previous article, that investment demand was already understated by at least half by the major silver reporting agencies.

1 Chilton, Bart (Ocotber 26, 2010) Statement at the CFTC Public Meeting on Anti-Manipulation and Disruptive Trading Practices. U.S. Commodity Futures Trading Commission, Speeches & Testimony. Retrieved on December 3, 2010 from: http://www.cftc.gov/pressroom/speechestestimony/ chiltonstatement102610.html 2 Hagens Berman Sobol Shapiro LLP (November 3, 2010) JP Morgan and HSBC Face RICO Charges in Silver Futures Class Action Lawsuit. Retrieved on December 3, 2010 from: http://www.prnewswire.com/news-releases/hagens-berman-sobol-shapiro-jp-morgan-and-hsbc-face-rico-charges-in-silverfutures-class-action-lawsuit-106624128.html

November 2010

It will be hard for them to downplay the recent demand increase, as the volume of silver contracts traded on the COMEX market on November 10th set a new record, surpassing the previous record set in December 1976 by 57%!3 This increase actually forced the CME Group to increase the margin requirements for COMEX silver futures twice in one week in order to maintain some semblance of market order.4 Silver coin sales as reported by the worlds major mints have also been exploding since Chiltons comments were made. The US Mint, The Royal Canadian Mint, The Austrian Mint and The Perth Mint are all reporting record or near record sales of silver coins.5 The silver Eagle produced by the US Mint set three new records at various points in November: best annual sales, best silver Eagle mintage, and best ever month.6 Money is pouring into silver in all forms, and due to silvers relatively small market size, this capital inflow is having a huge impact on the silver spot price. As we outlined in our Sprott Physical Silver Trust prospectus and our June MAAG article, the physical silver market is surprisingly small in US dollar terms. The CPM Group estimates that above ground stocks of physical silver total 1.184 billion ounces in bar and coin form, implying a total silver market size of a mere US$33.15 billion dollars.7 At the end of 2009, approximately 500 million ounces of that 1.184 billion were already accounted for by the silver ETFs and other large holders. This left approximately 684 million ounces of silver available for sale in 2010. That is hardly enough, in our opinion, to satiate demand.
Source: Sprott Asset Management

The money flows into silver in November 2010 have been staggering. Consider the investment demand generated from only two sources: the iShares Silver Trust ETF (SLV) and US Mint coin sales. The SLV added approximately 18 million ounces of silver in November alone; the US Mint sold 4.2 million ounces of silver coins. If you multiply these amounts against todays silver price of $28, money is flowing into the silver market at an annualized rate of $7.5 billion dollars! At that rate of demand, it wont take long before all the remaining above ground silver is spoken for. Silvers demand profile may also benefit from the outrageous short position that exists in the silver COMEX market. The current open interest in silver COMEX contracts totals an approximate 871 million ounces (!!!).8 This means there are paper contracts for over 871 million ounces of silver that have someone betting long and someone else betting short. In the event that the longs choose to take physical delivery, there will not be enough silver to supply each buyer. Its simple math - with only 684 million ounces of silver available above ground, there wont be enough silver to go around. And considering the rate with which people have been purchasing coins and silver bars this past month, there may not even be enough physical to satiate regular spot buyers, let alone futures market participants. Considering all the recent developments in the silver market, it seems unlikely that the silver price will stay under $30/oz for long. The large quantity of money flowing into silver from investors, combined with the potential demand from those who are short silver that they do not own, will likely end up swamping the physical silver market entirely.

3 4

5 6 7 8

Carlson, Debbie (November 10, 2010) Silver Contract Post Record Volume Tuesday CME Group. Kitco News. Retrieved from: http://www.kitco. com/reports/KitcoNews20101110KN.html Whittaker, Matt. (November 9, 2010) DJ CME Group To Raise Silver Futures Margin To $6,500 From $5,000. Trading Markets.com. Retrieved on December 3, 2010 from: http://www.tradingmarkets.com/news/stock-alert/cme_dj-cme-group-to-raise-silver-futures-margin-to-6-500from-5-000-1295499.html, CME Group. (Monday November 15, 2010) Performance Bond Requirements. Retrieved from: http://www.cmegroup.com/ tools-information/lookups/advisories/clearing/files/Chadv10-465.pdf The Silver Institute. (November 24, 2010) Another Record Year for U.S. American Eagle Silver Bullion Coin Sales. The Silver Institute. Retrieved on December 3, 2010 from: http://finance.yahoo.com/news/Another-Record-Year-for-US-bw-3849546583.html?x=0&.v=1 Coinnews.net. (November 22, 2010) 2010 Silver Eagle Scores Three Records. Coinnews.net. Retrieved on December 3, 2010 from: http://www. coinnews.net/2010/11/22/2010-silver-eagle-scores-three-records/ CPM Group. The CPM Silver Yearbook 2009. (April 2009) John Wiley & Sons. Pg 25. U.S. Commodity Futures Trading Commission. Commitment of Traders (COT) Report November 30, 2010. Retrieved on December 3, 2010 from: http://www.cftc.gov/dea/options/other_lof.htm. The open interest as of November 30th is 174,328 contracts.

November 2010

As our dear friend, Marc Faber, espouses in his book Tomorrows Gold, an investor can do very well by only making a few good investment decisions over his or her career. The trick is to make one good investment decision every decade or so, based on trends that will last a number of years.9 In our view, owning physical silver and the associated stocks represents that type of investment opportunity today. If that seems too simplistic, consider that in October 2001 we wrote an article that identified the investment of the last decade. It too was just a simple metal. The article was entitled All that Glitters is Gold, and it was written when gold was still considered a relic in financial circles. We believe silver will be this decades gold, and judging by the recent price action, its already off to a great start.

9 Financial Sense Newshour with Jim Puplava. Marc Faber, Tomorrows Gold Asias Age of Discovery. (2003). Retrieved on December 3, 2010 from: http://www.financialsensearchive.com/transcriptions/2003/Faber2003.html

Sprott Asset Management LP Royal Bank Plaza South Tower 200 Bay Street Suite 2700, P.O Box 27 Toronto, Ontario M5J 2J1 T: 416 943 6707 F: 416 943 6497 Toll Free: 888 362 7172

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The opinions, estimates and projections (information) contained within this report are solely those of Sprott Asset Management LP (SAM LP) and are subject to change without notice. SAM LP makes every effort to ensure that the information has been derived from sources believed to be reliable and accurate. However, SAM LP assumes no responsibility for any losses or damages, whether direct or indirect, which arise out of the use of this information. SAM LP is not under any obligation to update or keep current the information contained herein. The information should not be regarded by recipients as a substitute for the exercise of their own judgment. Please contact your own personal advisor on your particular circumstances. Views expressed regarding a particular company, security, industry or market sector should not be considered an indication of trading intent of any investment funds managed by Sprott Asset Management LP. These views are not to be considered as investment advice nor should they be considered a recommendation to buy or sell. The information contained herein does not constitute an offer or solicitation by anyone in the United States or in any other jurisdiction in which such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such an offer or solicitation. Prospective investors who are not resident in Canada should contact their financial advisor to determine whether securities of the Funds may be lawfully sold in their jurisdiction.