While the silver price continues to consolidate, and seasonality keeps hope alive, 2022’s ills are far from cured.
While I warned throughout 2021 and 2022 that inflation, employment, consumer spending and growth would light a fire under the FFR, interest rates have increased sharply. Moreover, while the crowd expects a dovish pivot, the narrative materially contrasts the data.
Please see below:
To explain, the dark brown line above tracks economists’ consensus GDP growth estimate for the fourth quarter, while the gray and light brown lines above track the consensus projections for Q1 and Q2 2023.
However, the red line above tracks the Bloomberg U.S. Economic Surprise Index. For context, a ‘surprise’ occurs when a data point outperforms the consensus estimate. If you analyze the red line’s ascent, you can see that resilient economic data has been present for the last few months.
So, while I warned that a dovish pivot requires a collapse in growth, inflation and the U.S. labor market, that scenario is far from the current environment. Consequently, the investors bidding up the silver price will likely suffer profound disappointment as the Fed keeps pushing the FFR higher.
To that point, silver is more cyclical than gold, so it has a higher sensitivity to the U.S. business cycle. In addition, silver and mining stocks are more volatile than gold, and they often suffer mightily when the S&P 500 exhibits weakness. As such, with the fundamental backdrop contrasting the conditions that support stock market bottoms, the S&P 500’s plight could weigh heavily on the silver price in the months ahead.
For example, Bridgewater Associates is the largest hedge fund in the world. Co-Head of Equities Research Erin Miles wrote on Nov. 11:
“The equity bottom typically does not come until 1) there is a meaningful period of easing sufficient to offset the negative economic momentum, and 2) equity prices fall enough that investors are incentivized to move back out the risk curve and buy stocks.
“The former typically means that central banks assess that the slowdown in economic activity has been large enough to bring inflation back under control. And the latter means equities typically decline much more than justified by higher interest rates, resulting in valuations that are low enough to draw investors back in.
“When we look at conditions today, the typical markers of an equity market bottom are not yet present.”
Please see below:
Source: Bridgewater Associates
To explain, the heat map above contrasts the fundamental conditions present during historical stock market bottoms with today's conditions. If you analyze the first several rows, you can see that high inflation is often present, combined with weak growth, high unemployment and the Fed cutting interest rates.
Conversely, the bottom row highlights how today's environment has high inflation, moderate growth, low unemployment and a Fed that's still raising interest rates. As a result, few of the boxes are checked, and I've warned on numerous occasions that bear markets don't end with the unemployment rate at a ~50-year low.
Furthermore, the report added:
“Growth is typically below potential going into inflation-driven equity market troughs, as the Fed usually needs to see weak conditions to ease and turn the market. The main exception was 1984.”
Please see below:
Source: Bridgewater Associates
To explain, the red markers above show how outside of 1984, U.S. GDP growth tracks below potential three months before the stock market bottoms. However, the right side of the chart shows how the blue line remains near neutral. Thus, the stock market hasn’t reconciled the demand destruction that often unfolds before a long-term low is achieved.
Also noteworthy, valuation is an important driver of stock prices over the long term; and with the S&P 500’s price-to-sales (P/S) ratio still near its dot-com bubble high, the current reading is nowhere near recent stock market bottoms.
Please see below:
To explain, the blue line above tracks the S&P 500’s P/S ratio. If you analyze the horizontal red line, you can see that the current reading of 2.32 is far from cheap.
More importantly, the orange circles highlight how troughs in 2020, 2018, 2009 and 2002 occurred with the metric below 2 and 1.5; and while the bulls are not fans of data, the numbers suggest this bear market still has plenty of room to run.
Overall, while the silver price remains elevated, the bullish seasonal period has investors overlooking the ominous outcomes that proceed abnormally high inflation and abnormally low unemployment; and while sentiment can keep the S&P 500 and the white metal levitated in the short term, the downside could be immense when the momentum reverses.
Mixed PMIs
The Fed's regional PMIs are valuable because they're like puzzle pieces that create the fundamental whole. So, while mixed results were present recently, they have not been sharp enough to support a dovish pivot.
For example, the Richmond Fed released its Fifth District Survey of Manufacturing Activity on Nov. 22. The headline index increased from -10 in October to -9 in November, and the employment index was roughly flat. The report stated:
“The wage index decreased notably from 34 to 25 in November but remained elevated.”
Furthermore:
“The average growth rate of prices paid decreased in November, while the average growth rate of prices received increased somewhat. Expectations for prices paid over the next 12 months decreased slightly since last month, while expectations for prices received increased slightly.”
As a result, the modest rise in output prices highlights why the Fed is far from achieving its 2% inflation goal.
Please see below:
Source: Richmond Fed
Also, the Dallas Fed released its Texas Manufacturing Outlook Survey on Nov. 28. The headline index increased from -19.4 in October to -14.4 in November, and the report stated that “labor market measures pointed to slower employment growth and stable hours worked,” while “price growth eased, while wage growth remained elevated.”
In addition, the Dallas Fed’s Texas Service Sector Outlook Survey (released on Nov. 29) showed the headline index increased from -13.6 to -11, and an excerpt read:
“Labor market indicators suggested continued growth in employment and hours worked in November,” and “growth in selling and input prices continued to moderate in November, while wage pressures picked up slightly.”
Thus, there is no smoking gun. However, with this month’s “special questions” providing some interesting insights, they showcased why the Fed’s inflation fight will be one of attrition. For context, manufacturing, service sector and retail firms are included in the results.
Please see below:
Source: Dallas Fed
To explain, when asked about how firms plan to deal with the higher input costs and wages, more than 50% of respondents said they plan to increase their output prices in 2023. Plus, the figure is much higher than the ~29% recorded in May.
Likewise, the row above shows that ~69% of Dallas firms still plan to raise prices this year. As a result, an inflationary mindset is hard to break, and a dovish pivot would only enhance businesses’ reaction function.
So, while the pricing pressures have eased somewhat, the Fed is still a long way from solving its inflation conundrum.
The Bottom Line
While gold, silver, mining stocks and the S&P 500 continue to prioritize seasonality, the medium-term technicals and fundamentals are profoundly bearish. Moreover, while the crowd hopes that Powell will throw them a bullish bone, 2021 and 2022 have shown that his words have no bearing on the fundamentals.
Consequently, while investors assume that he can eliminate inflation and orchestrate a soft landing by waving a magic wand, the reality is that no Fed committee since 1954 has achieved what the consensus assumes he will. Therefore, while a lack of short-term bearish catalysts are seen as bullish, plenty of ‘surprises’ should unfold in the months ahead.
In conclusion, the PMs rallied on Nov. 29, as the USD Index and the U.S. 10-Year real yield continue their consolidations. But, with the pair poised to seek higher ground over the medium term, the fundamentals should showcase their might as this bear market evolves. As such, we believe that gold, silver, mining stocks and the S&P 500 have not seen their final lows.
Alex Demolitor
Precious Metals Strategist