How long can the white metal save the crowd from the bearish fundamentals?
While a lack of positive signals helped the S&P 500 continue its recent downtrend, silver could care less. Despite the index’s plight, rising nominal and real yields, and liquidity-fueled assets being left for dead (like Bitcoin and the ARKK ETF), the silver price behaves as if none of it matters.
Although, while its resilient response may seem like a sign of strength, we know from experience that silver’s outperformance is bearish, not bullish. So, while the momentum investors have ditched stocks and bonds and piled into the PMs, the ominous fundamentals should reign supreme in the months ahead.
For example, nine of the last 10 inflation fights have ended with recessions since 1948; and when liquidations occur, risk assets suffer mightily. As evidence, we wrote on Nov. 28:
Since no bear market since 1929 has ended before a recession began, a confluence of historical data materially contrasts the bullish narrative.
Please see below:
To explain, the light green blocks above represent bear markets and the horizontal dark green lines represent recessions. The data shows that bear markets suffer more downside when recessions hit, while the gray arrows show that bear markets without recessions are often short-lived.
Furthermore, since a recession hasn’t occurred in 2022, the bulls can point to 1966 and 1987 as similar analogies. However, with significant economic weakness poised to materialize as the Fed battles inflation, even the FOMC thinks a 2023 recession is highly likely. As such, this bear market should have plenty of room to run.
To that point, history shows that battling inflation is highly troublesome, and higher interest rates should demonstrate their might in 2023.
Please see below:
To explain, the blue line above tracks the Institute for Supply Management’s (ISM) manufacturing PMI, while the red line above tracks the inverted (down means up) YoY change in the 30-year fixed mortgage rate (30YM).
If you analyze the relationship, you can see that higher long-term mortgage rates often capsize demand and weigh on the American manufacturing sector. Moreover, while an ISM PMI below 50 signals a contraction in economic output, the red line on the right side of the chart is calling for ~25. Therefore, major economic slack could materialize in 2023.
Yet, please note that the 30YM often leads the ISM PMI by 19 months, so it’s not an instantaneous recalibration. But, with a higher FFR needed to curb inflation, higher Treasury yields and mortgage rates should be the drivers of a late 2023 recession.
In addition, with U.S. banks tightening their lending standards, their credit conservatism is another indicator of trouble ahead.
Please see below:
To explain, the blue line above tracks the net percentage of banks that are more/less willing to lend money to consumers. If you analyze the relationship, you can see that recessions (the vertical gray bars) often follow when the spread turns negative.
As such, with the blue line falling below zero on the right side of the chart, the implications are bearish and silver has not priced in the ramifications.
Speaking of which, if a recession occurs in late 2023, a liquidation-style event will likely upend all risk assets, especially the S&P 500, silver and mining stocks.
Please see below:
To explain, the green line above tracks the S&P 500’s equity risk premium (ERP). If you analyze the right side of the chart, you can see that the abnormally low reading rivals the compliancy that occurred before the 2008 global financial crisis (GFC).
Furthermore, the black circles above show how high the metric can rise when bouts of panic occur. Therefore, while a mild recession could normalize the ERP near 6%, a hard landing could push it toward the 7% to 10% range. Consequently, with the current ERP closer to 4%, investors are pricing in an unrealistic outcome, and a profound wake-up call should commence in the months ahead.
Overall, while silver has been unflappable in the face of several bearish developments, it’s likely only a matter of time before reality remerges. Throughout 2021 and 2022, we witnessed periods where the PMs ignored the plight of stocks and bonds, only to suffer sharp drawdowns soon after. Thus, is this time really different?
Alex Demolitor
Precious Metals Strategist1