Silver Ignores All of the Stop Signs

While it’s been full steam ahead for silver, is an accident waiting to happen?

While several risk assets exhibit caution, silver has been off to the races. However, the white metal is known for false breakouts, and fading these moves is a staple within our gold trading tips . Therefore, while the crowd likes to buy high and sell low, the recent rally in the silver price highlights why caution is warranted.

For example, lower interest rates and a weaker USD Index have increased the PMs’ fundamental attractiveness. Yet, the moves are driven by the false belief that inflation has been curtailed and the Fed can turn dovish. So, when reality re-emerges and the pair continue their medium-term uptrends, silver’s strength could turn into immense weakness.

Please see below:

To explain, Goldman Sachs expects the FFR to peak between 5% and 5.25% (the black line above). Moreover, while the U.S. 10-Year Treasury yield (10Y) ended the Dec. 9 session at 3.57%, the investment bank expects it to rise to 4.5% in 2023 (the gray line above) before settling at 4.3%. As a result, when the pullback in interest rates reverses, silver’s gains should reverse as well.

Remember, the 10Y and the USD Index have moved in tandem for the last ~14 months; and since higher interest rates are bullish for the greenback, inflationary realities should push both metrics higher in the months ahead.

Please see below:

To explain, the red line above tracks the 10Y, while the green line above tracks the USD Index. If you analyze the relationship, you can see that the two have largely followed in each other’s footsteps; and while their pullbacks on the right side of the chart have been bullish for the PMs, we view them as countertrend declines within medium-term uptrends. As such, we expect new highs to materialize in 2023.

Likewise, the technicals are just as ominous, and silver’s outperformance of gold is an important sell signal because it often soars and breaks above its previous highs (or other important resistance lines) only to fool those who are new to this market; and then it slides. Thus, the sharpest rallies often occur right before a collapse.

Furthermore, CNBC released its Q4 Small Business Index on Dec. 9. The article stated:

“More players in the stock market and among the ranks of professional economists have come around to the view that inflation has peaked or already is in decline, but small business owners on Main Street don’t expect a reprieve from high prices anytime soon.

“An overwhelming majority (78%) of America’s entrepreneurs say they expect inflation to continue to rise, according to the quarterly CNBC|SurveyMonkey Small Business Survey. That is effectively unchanged from last quarter when 77% said they expected inflation to continue to rise.”

So, while the narrative proclaims that inflation is old news and a dovish pivot can commence, the businesses operating on the ground paint a significantly different portrait.

Please see below:

Source: CNBC

Consequently, while investors often extrapolate short-term trends into perpetuity, we’ve warned repeatedly that the Fed’s inflation fight will be one of attrition, and market participants underestimate the peak FFR and the need for tighter financial conditions.

In addition, debtors borrow money over the long term, so if the 10Y, 20Y, 30Y, etc. don’t rise, it will be difficult for the Fed to reduce demand for capital and cool inflation. Thus, the fundamentals are bullish for the FFR, real yields and the USD Index, and bearish for silver.

Also noteworthy, the University of Michigan released its Consumer Sentiment Index on Dec. 9; and with Americans increasingly bullish on their earnings prospects, it’s another indicator of why demand destruction still awaits us.

Please see below:

To explain, the brown line above tracks respondents’ expected change in household income over the next 12 months. If you analyze the right side of the chart, you can see that the metric has risen for three straight months and is now at its highest level since 2007.

As a result, with wage inflation reaccelerating and Americans increasingly optimistic about their income outlook, the pivot predictors are pumping a narrative that contrasts the hard data; and with prior iterations ending badly for the believers, this one should be no different.

Overall, while seasonality and momentum have silver riding high, the fundamentals are profoundly bearish. Wages are rising, financial conditions have loosened materially and outside of lowering commodity prices, the Fed has made little progress in its inflation fight. Therefore, when sentiment shifts, it could be a long way down before the silver price finds a floor.

Alex Demolitor
Precious Metals Strategist