Will Silver Prices Ride on a Second Inflation Wave?

Disinflation continues, but it is too soon to celebrate – core inflation is still there and rising. If we let the guard down too soon, it might take over.

I don’t want to spoil the party. But I have to. We, economists, are believed to be dismal. Everyone marvels right now at the falling inflation rate. Indeed, there is much to rejoice about, and disinflation should be welcome! Moreover, given how it looked in the 1970s, inflation could return to the Fed’s target by mid-2024. Not bad at all! This is at least what the chart below suggests (courtesy of goldpriceforecast.com). The blue line shows the annual CPI inflation rate in 1967-75, while the green one – in 2015-2022. As you can see, the similarities are striking; if it holds, inflation could normalize next year.

However, there is one problem (which was pointed out by Jesper on this blog). Inflation is more widespread now than in the 1970s. Although the overall inflation has been falling for six months, the sticky core inflation has not, as the chart below shows. Even though energy prices are declining, dragging down the overall rate, the core inflation won’t necessarily follow suit.

Will We See a Second Wave of Inflation?

The reason why inflation could be more persistent is clear. The U.S. central bank made an obvious policy mistake and didn’t raise interest rates until March 2022 when inflation was already running a red-hot 8%. This complacency allowed inflation to entrench stronger into the economy, which could make it more difficult to beat.

The threat here is obvious. There could be a second wave of inflation. This is what happened in the 1970s (see the chart below, which is the same as the first one but with a bit longer series by the end of the 1980s). As you can see, the second wave was even more detrimental than the first one! And it came because there was another negative economic shock that happened when inflation was still elevated after the first wave.

It’s not too difficult to imagine a similar scenario today. After all, a recession is coming, which could lead to easy fiscal policy and lax monetary policy again. Add to this another energy crisis or supply shock, and here we go again…

Implications for Silver

What does it all mean for the silver (and gold) outlook for 2023? Well, if the Fed doesn’t want a replay of the Great Stagflation from the 1970s, it could be forced to keep interest rates at a high level for another several months. In the 1970s, it started to ease its stance too quickly, which led to a second wave. This is a huge risk for silver because this analysis suggests that the Fed could continue its hawkish stance for longer than the markets currently anticipate. If that happens, the current upward trend in silver (see the chart below, courtesy of silverpiceforecast.com) could reverse.

However, the bullish case is not lost. First, a recession is likely to come before any second wave of inflation, so silver prices should still go up. Second, if there is a second wave, there could be stagflation and panic in the markets, also supporting silver prices. Third, the Fed can easily commit another mistake and let the guard down too early. I wouldn’t be surprised, would you?

Arkadiusz Sieron, PhD