Will Silver Stay Cool During the Dry Season?
A continued liquidity drain could have the pivot bulls seeing red.
While the PMs attempt to front-run a potential dovish pivot, the thesis is built on the premise that the FFR is approaching its peak. In essence, if the worst of the liquidity drain is near, the crowd will position for the shift by purchasing the PMs in advance.
However, we warned on Dec. 22, that like in 2021, investors misjudge the hawkish implications of unanchored inflation. We wrote:
Nine of the last 10 inflation fights ended with recessions since 1948; and if inflation was easy to defeat, the historical ramifications wouldn’t be so ominous. In addition, we warned that the FFR has eclipsed the peak YoY core CPI in every inflation fight since 1961. Likewise, since the YoY core CPI peaked (for now) at 6.66% in September 2022, the historically-implied peak FFR is at least 6.67%.
Overall, investors believe inflation will subside with little economic damage, and this misguided optimism uplifts gold, silver and mining stocks. But, a realization requires the Fed to accomplish something it’s only done once since 1948, and as it relates to a lower FFR than the peak YoY core CPI, something it’s never done. Therefore, we’re happy to take the other side of the trade.
So, while the white metal opened the New Year in style, the medium-term silver bulls underestimate the impending liquidity drain.
Please see below:
To explain, the Atlanta Fed increased its Q4 real GDP growth estimate (the green line above) from 3.7% on Dec. 23 to 3.9% on Jan. 3. As a result, resilient economic growth is bullish for the FFR, and provides Fed Chairman Jerome Powell with more leeway to remain hawkish for longer.
As such, while we warned that demand was the main driver of inflation, the resilience of GDP growth supports the thesis. Moreover, it’s another indicator of why the FFR needs to align with history and rise by much more than the consensus expects, and the ‘this time is different’ crowd should suffer as the liquidity drain continues.
To that point, we warned on Dec. 13 that investors’ optimism and pessimism impact the Fed’s inflation fight. We wrote:
The crowd believes that lower inflation is a linear process of positive results. However, the pessimism that confronted the financial markets from mid-August to mid-October lowered asset prices and helped calm today’s inflation metrics. Conversely, with that pessimism reversing recently and financial conditions loosening, the current optimism sets the stage for higher inflation over the medium term.
Furthermore, market participants don’t realize that the inflation merry-go-round will spin if they keep overreacting to relatively immaterial progress. In other words: investors’ hopes for a dovish pivot actually reduce the chances of one occurring.
Thus, with the latest update from the Cleveland Fed highlighting the phenomenon, one month’s pivot enthusiasm is next month’s disappointment.
Please see below:
Source: Cleveland Fed
To explain, the red rectangle at the top of the table above shows that a 0.12% month-over-month (MoM) increase in the headline CPI is expected in December, while a 0.66% MoM rise is expected in January. Consequently, the ‘old economy’ optimism that's occurred in recent weeks may keep the headline CPI from making any progress on a YoY basis (the red rectangle at the bottom).
Also, the second column to the right shows that the core CPI is expected to remain uplifted, as 0.48% MoM increases lead to only a small dip on a YoY basis.
Please note, a 0.66% MoM increase annualizes to 8.2%, while a 0.48% MoM increase annualizes to 5.9%. Therefore, the crowd’s pivot optimism has largely eroded the recent inflation progress, and the fundamentals continue to unfold as expected.
Remember, we warned repeatedly that ‘peak CPI’ is irrelevant. In reality, what matters is how much economic pain is required to normalize the metric to 2%; and with history highlighting the difficulty of achieving this goal, inflation’s propensity to jump around is far from priced in, and a higher FFR should drastically shift sentiment over the medium term.
On top of that, we also warned on numerous occasions that wage inflation is the canary in the coal mine. In a nutshell: with Americans' ability and willingness to spend poised to keep inflation uplifted, it puts more pressure on the Fed to suppress demand.
Likewise, with 26 states implementing minimum wage increases in 2023, the misguided policy will only spur more inflation. Holly Sklar, CEO of Business for a Fair Minimum Wage, said:
“Putting needed raises in minimum wage workers’ pockets [is] really the most efficient way you can boost the economy. Those are the people who have to go right back around and spend it.”
As a result, while she views the initiative as a positive, the strategy is akin to putting out a fire by pouring on more gasoline.
Please see below:
Overall, silver has outperformed gold in recent weeks, but our experience shows that this phenomenon is bearish. So, while the white metal remains uplifted for now, the fundamentals signal a drastically different outcome over the medium term.
Precious Metals Strategist