Inflation Hit Silver First, Will a Recession Be Next?

The bulls run for the exit whenever silver hits $24.

While we warned throughout 2021 and 2022 that unanchored inflation was counterintuitively bearish for the PMs – due to its propensity to wake up the bond market and the Fed – the prediction proved prescient as the QE beneficiaries declined sharply from their pandemic peaks. 

Yet, only one-half of our fundamental thesis has played out, and a recession should help push silver to new lows. We’ve noted how nearly all rate-hike cycles and inflation fights end with recessions, and since liquidations confront the financial markets when panic erupts, all risk assets suffer. 

Sure, gold may outperform the S&P 500 in a recessionary sell-off, but mining stocks and silver often suffer mightily. Therefore, with silver unable to hold $24 and its 50-day moving average rising each day, a short-term breakdown should be the first step along the road to a new nadir.  

For example, while Goldilocks has been priced into risk assets – meaning rate cuts, low inflation and high corporate earnings – the consensus outcome is highly unrealistic. Conversely, it’s much more likely that this cycle ends with rate increases, low inflation and low corporate earnings.

Please see below:

To explain, the light blue line above tracks the YoY percentage change in U.S. GDP, while the dark blue line above tracks the implied value in Q3 2023 from Nordea’s GDP model. If you analyze the relationship, you can see that it’s a tight fit.

More importantly, the dark blue line’s deceleration on the right side of the chart signals a material recession in the back half of 2023. As such, our fundamental thesis should have plenty of room to run.

As further evidence, the slowdown in industrial production is a recessionary canary in the coal mine. 

Please see below:

To explain, the blue line above tracks the z-score (ZS) of the YoY percentage change in industrial production, while the red dashed line above tracks the ZS of the six-month percentage change in the index of leading indicators (advanced by six months). 

If you analyze the horizontal blue lines, you can see that whenever the leading index ZS has been ~1.5 standard deviations below the long-term average, a recession has occurred. Therefore, while industrial production remains supported for now, the leading index reading on the right side of the chart makes the medium-term implications profoundly bearish.

From another angle, the spread between the 3-month U.S. T-Bill yield (3M) and the U.S. 10-Year Treasury yield (10Y) is another recession omen. 

Please see below:

To explain, the black line above subtracts the 3M from the 10Y, and when the spread turns negative, the bond market is pricing in a higher FFR (hawkish Fed) and a potential recession (lower long-term yields). 

Moreover, it also has a flawless track record, and the major inversion on the right side of the chart rivals the 1970s/1980s. So, again, it’s likely a matter of when, not if, the next recession occurs.

To that point, we’ve long warned that a pivot amid high inflation is bearish, not bullish. In a nutshell: when inflation is high and yield curves invert, the eventual recession overpowers the jubilation of rate cuts.

Please see below:

To explain, the black and brown lines above track the median performance of stocks when the yield curve isn’t and is inverted. As you can see, the brown line heads materially lower when the recessionary impact of inverted curves becomes apparent. 

Furthermore, the vertical gray dotted line near the left side of the chart represents the Fed’s last rate hike (dating back to 1971). As you can see, pivots, pauses or whatever you want to call them, are bearish when inflation is high and yield curves are inverted. 

As it stands, our recurring message holds true: the fundamentals guide the Fed, not the other way around. Therefore, regardless of what Fed Chairman Jerome Powell says or does, he can’t change the ramifications of what’s already occurred. Inflation is too high, and the bond market is telling you that Powell can’t win this war without a recession. 

In addition, the 1970s showed that rate cuts amid high inflation didn’t work either, as the FFR reversed higher, and recessions followed. Consequently, whether he hikes, pauses or cuts, the cycle should end the same, and the crowd is ignoring these historical lessons at their own peril. 

Overall, the silver price is hanging on by a thread, and the second part of our fundamental thesis likely lies ahead; and while a resilient U.S. labor market has delayed the drama, the strength won’t last forever. Thus, with the USD Index a major beneficiary when recessionary panic unfolds, the months ahead should be bullish for the greenback and bearish for the PMs. 

How soon could a recession occur? Or, do you believe this cycle will end with a soft landing? Why does the crowd think rate cuts amid high inflation are bullish, despite the contrasting historical record?

Alex Demolitor
Precious Metals Strategist