- After breaking above short-term down trendline resistance last week, silver looks set for run at key neckline resistance going back to 2014, above which would target the $20 level.
- The technical picture for silver chimes with the move higher we have seen across industrial metals prices, with copper prices trending particularly strongly, smashing above short-term trendline resistance.
- The ongoing decline in real bond yields and rally in industrial metals prices provides the perfect fundamental backdrop. Silver continues to trade 20% below our measure of short-term fair value.
- We continue to see a long-silver, short-equity position is a low risk pair trade with potential for both legs to benefit once stagflation takes hold.
The technical and fundamental outlook for silver prices remains highly positive as the metal looks set to challenge key downtrend resistance as positive tailwinds in the form of rising gold prices and the recovery in the commodity complex suggest ~20% near-term upside. We continue to expect the strong correlation between SLV and SPY to break down in favour of silver over the coming months. A long-silver, short-equity position is a low risk pair trade with potential for both legs to benefit once stagflation takes hold.
Technical Picture Gathering Momentum
After breaking above short-term down trendline resistance last week, silver looks set for run at key neckline resistance going back to 2014. A break above here and the $20 level would trigger the completion of a large bottoming pattern suggesting a run at the $30 area as the long-term bull market resumes.
Taking Out Key Resistance Levels
The technical picture for silver chimes with the move higher we have seen across industrial metals prices, with copper prices trending particularly strongly, smashing above short-term trendline resistance and looking to resume their multi-decade bull market.
False Downside Break Puts Focus Higher
At the heart of the ongoing rally in inflation assets is the continued decline in U.S. real interest rates and bond yields. The Fed’s efforts to prevent a deflationary crash in March by ramping up asset purchases have seen inflation expectations recover strongly while nominal yields have remained pinned near record lows. Despite the contraction in the Federal Reserve’s balance sheet last week, inflation pressures continue to build.
Fundamental Backdrop Continues To Improve
The ongoing decline in real bond yields and the strong rally in industrial metals prices provides the perfect backdrop for a silver price rally. Silver continues to trade roughly 20% below our measure of short-term fair value calculated using gold prices and the continuous commodity index (NYSE:CCI). Based on historical correlations, the ongoing rally in gold prices and the strong recovery in the CCI suggest that silver should be trading around $23. Furthermore, the ongoing deterioration in the U.S. fiscal outlook suggests continued debt monetisation and deeply negative real yields.
Silver Still Trades At A Discount To Short-Term Fair Value
Source: Bloomberg, Author’s calculations
High Cross-Asset Correlations To Decline In Favour Of Silver
As a result of this extreme monetary policy response to the Covid-19 crash, correlations across inflation-sensitive assets remain extremely high. We have had a number of comments on previous silver articles asking whether the close correlation between silver and U.S. equities will remain intact and whether a fall in U.S. stocks would drag down silver prices. In the short term we believe the answer is yes; any pullback in one inflation-sensitive asset is likely to correspond with a pullback in others. However, we would still expect to see silver prices to outperform stocks as any resumption in risk-off sentiment leads to increased expectations of further monetary easing, keeping real yields depressed and supporting silver’s attractiveness as a store of value.
Over the longer term we should expect declining U.S. stocks to actually be positive for silver. As we argued in ‘SLV: Silver To Shine During Inflationary Equity Bear Market’, as inflation pressures begin to rise in earnest, equities tend to struggle while precious metals perform well. The following chart shows the ratio of the SP500 over XAG pitted against headline inflation. Despite what mainstream economists tell us, rising inflation tends to reflect economic weakness which simultaneously raises the appeal of precious metals and reduces the appeal of equities. As we saw in late-2007, early-2008, economic weakness led to a deeply inverse correlation between silver and the SP500 as silver rose while stocks fell.
Source: Bloomberg, Author’s calculations
Stocks Are Risk Assets, Not Stores Of Value
Equities have been closely inversely correlated with real bond yields since the March crash as speculators have looked to take advantage of looser monetary policy to drive up stock valuations to new extremes. However, unlike in the case of precious metals, real interest rates are not a particularly strong driver of equites because equities are risk assets rather than stores of value. Over the past 20 years equity valuations have tended to rise amid higher real yields reflecting expectations of stronger growth. This upshot is that while silver and stocks may remain closely correlated in the near term, a long-silver, short-equity position is a low risk pair trade with potential for both legs to benefit as stagflation takes hold.