The white metal’s countertrend rally may have run out of steam.
While the S&P 500 may be forming a short-term bottom, the index has gone nowhere for roughly two months. Furthermore, we warned on Oct. 26 that overzealous bulls would face resistance at these levels. We wrote:
With two of the four largest companies in the S&P 500 suffering, the squeeze may have already run its course. Moreover, while positioning is still heavily short, the index offered tactical value near 3,600, not 3,850.
In addition, with the bearish medium-term fundamentals rearing their ugly head, and the Fed poised to raise interest rates by 75 basis points next week, stocks offer a poor risk-reward proposition when the FFR should hit 4%.
As a result, with the S&P 500 ending the Jan. 5 session at ~3,808, the moral of the story is that risk assets are unattractive when cash returns are 4.25%+. Therefore, while the silver price remains well above its 2022 lows, we expect the white metal and the S&P 500 to hit new nadirs in 2023.
To that point, the FOMC reiterated its hawkish message recently, and the crowd is ignoring the implications at their own peril. For example, Minneapolis Fed President Neel Kashkari released a research report on Jan. 4; and despite our plethora of warnings about unanchored inflation throughout 2021, Kashkari began his article with a mea culpa. He wrote:
“To state clearly, I was solidly on ‘Team Transitory,’ so I am not throwing stones. But many of us – those inside the Federal Reserve and the vast majority of outside forecasters – together made the same errors in, first, being surprised when inflation surged as much as it did and, second, assuming that inflation would fall quickly.”
Thus, while the consensus still assumes “that inflation [will] fall quickly,” they underestimate the challenges that lie ahead. Remember, we've warned for many months that wage inflation was highly problematic. We wrote on Mar. 31, 2022:
Investors are miscalculating the resiliency of inflation. With supply-chain disruptions primarily blamed for the recent surge, market participants don’t realize that a severe shock to demand is needed to cool the pricing pressures. Moreover, with the U.S. labor market on fire and robust wage growth akin to pouring gasoline, how can the Fed expect inflation to calm when consumers remain flush with cash?
The housing market is the canary in the coal mine. Robust wages, all-time high checkable deposits and record employment opportunities allow buyers to service their mortgage debt with little worry. However, to reduce inflation, the Fed needs to flip the script; and this means fewer employment opportunities, lower wages, and eventually, lower checkable deposits.
Likewise, with Kashkari making the point for us on Jan. 5, he’s only nine months late to the party.
Please see below:
Source: Minneapolis Fed
More importantly, while the crowd remains steadfast that a pivot is on the horizon, we warned that substantial economic weakness is required for a dovish 180, and that’s not the economic reality right now. So, while Kashkari and the FOMC’s poor forecasting record can be debated, his message should prove prescient in the months ahead.
Please see below:
Source: Minneapolis Fed
While Kashkari wrote that “I have us pausing at 5.4 percent,” please note that a pause is not a pivot, and the current FFR is 4.25%. In addition, with a resilient labor market poised to keep the pressure on the Fed, the chances of “taking the policy rate potentially much higher” are greater than investors realize.
Remember, fundamental asset returns are driven by the difference between what’s priced in and what actually happens; and right now, the FFR is expected to peak at ~5% and the consensus expects rate cuts in 2023. As a result, there is plenty of room for hawkish re-pricing in the months ahead.
Finally, while the FFR garners all of the attention, the Fed’s balance sheet sunk to a new weekly low on Jan. 4 (updated on Jan. 5), and QT should intensify the liquidity drain over the medium term.
Overall, while the silver price shows signs of slippage, it's still materially above its fundamental and technical values. With the Fed poised to continue its hawkish crusade, and inflation poised to linger longer than the consensus expects, hawkish realities should depress sentiment in the months ahead. As such, we expect material downside before silver's bear market ends.
Alex Demolitor
Precious Metals Strategist