In absence of ETFs, rich investors buy unsecured silver-linked financial instruments

MUMBAI: Many rich investors are buying risky, privately-sold papers to ride a stunning rally in silver which they hope will go on for a while even as some fear it's nearing a bubble. At least three finance firms, a large bullion house and the portfolio management division of a venture capital fund are selling debentures and specially-designed instruments whose returns mirror the fortunes of silver.

According to market estimates, hundreds of well-heeled investors have put in more than 400 crore in such structured products, many of which do not offer a capital protection. Investors receive no fixed or guaranteed return and may end up losing a slice of their money if there is a crash in the price of silver. But if there is a surge in price, between 80 and 90% of the gains are shared with investors who in some schemes have to pay an upfront fee, similar to entry loads charged by mutual funds, to the seller of the debenture.

Since end-November, silver has risen 50% to 63,930 while gold is up by just 4% during the same period. As property prices looked shaky and stocks turned choppy, wealthy investors — known as HNIs or high net worth individuals in the financial market found silver irresistible.

Their counterparts in other parts of the world invested in exchange-traded funds with silver as the underlying asset. But in the absence of silver ETFs — a product that is awaiting the capital market regulator's approval for the last two years — Indian HNIs snooped around for silver-linked instruments. Financial intermediaries, bullion dealers and commodity exchanges were quick to sense the opportunity.

Brokerages and other entities floated special purpose vehicles to sell fancy debentures while commodity exchanges began aggressively marketing silver futures and spot products.

"Putting money in a 30-month or 40-month unsecured debenture with no capital protection is just like investing in stocks. It's no more or no less risky... It's up to the investor to take a call on whether silver will continue to rise. But investors must be confident of the credibility and competence of firms issuing such products," said Anup Shah, a chartered accountant, whose firm Pravin P Shah & Co has advised some of the issuers. The money raised by the issuer is invested in silver. There are combinations of investment strategy where the fund manager may invest in physical silver or silver futures.
Moving Towards Lifetime High

Thefund manager may also try to cash in on the arbitrage oppor-tunities between the spot and futures prices. According to a broker, investors have to be careful because the commodity trading desks of some of the large brokerages are not as smart as their stock trading divisions. However, with silver crossing Rs 60,000 a kilo, many investors are now insisting on silver-linked instruments that are less risky and promises to protect their capital, at least a large part of it. For capital protection products, around 80% of funds collected are invested into an instrument giving assured returns, say, an FD, of 2-3 years.

"More than the magnitude, the speed with which silver has risen has attracted investor interest," said Jayant Manglik , president, Religare Commodities . "Since mid-June last year, silver on the overseas market has more than doubled to $42 an ounce and is moving towards its lifetime high of $50 tested thirty one years ago. Indian prices have reflected the move overseas...... I feel investment rather than industrial demand, especially over the past four months, has been the prime driver of the rally," he said.

But even as a spiralling silver evoked memories of the silver bubble of the late '70s, engineered by Hunt brothers -- sons of a Texas oil billionaire -- and the dramatic crash of January '80, investors across the world bought silver. Besides the absence of ETF, another reason why complex debentures found takers in India is due to problems investors face in storing silver.

While Rs 21 lakh can be parked in a one-kilo gold bar tucked away in a vault, silver of the same value will occupy an entire cupboard. According to a well-known broker from an integrated financial services group, the average investment ticket size is around Rs 20 lakh, with each debenture priced at Rs 1 lakh. For many debentures, the underlying is the near month traded future in a comex.

The product, which was launched last year, turned popular over the past three months during which silver has been moving rapidly towards its 1980 record price of $50 an ounce (31.10 gm). What matters to investors of such products is the availability of an exit opportunity when they feel the market is overheated. Gnanasekar Thiagarajan, director of commodity research company Commtrendz, forecasts another $2 an ounce increase in silver to $45 in the near term after which it could witness a fall to $35. "The goldsilver ratio is hovering over 30, which has seldom been seen. My expectation is of a sharp correction once it tests $45. My reading suggests $35 is a strong support," said Thiagarajan.

Over any 10-year period, the rise in gold and silver has been more or less equal. "Since gold has risen every year since 2001 and silver has relatively lagged gold for the greater part, the metal began to make up for the lag since the previous year, felt Manglik.