Could Big Tech’s bloated valuations drag down the silver price?
While silver ended 2022 on a high note, the USD Index’s late 2022 pullback helped ease the burden of higher interest rates. Although, with a greenback comeback poised to materialize in 2023, the two-headed monster of a higher U.S. 10-Year real yield and a stronger USD Index should create an ominous fundamental backdrop for the PMs.
On top of that, with overvalued technology stocks poised to help push the S&P 500 to new lows, their plight should help upend silver in 2023. For context, we wrote on Dec. 30:
The S&P 500’s autumn slide culminated with the silver price sinking below $18; and while there could be a pathway to $30 in 2023, we believe that new lows for the S&P 500 should culminate with new lows for silver.
To that point, with the Fed’s balance sheet continuing to drop, QT has usurped QE; and with the development weighing heavily on Big Tech, the cascading effect could also capsize the silver price.
Please see below:
To explain, the dark blue line above tracks the FAANG+ index – which includes heavyweights like Facebook (Meta Platforms), Amazon, Apple, Netflix, Google (Alphabet) and others – while the light blue line above tracks the consolidated balance sheet of the five-largest central banks.
If you analyze the relationship, you can see that QE had been a boon for these stocks, as free money increased multiples and created abnormally high valuations. Conversely, with QT commencing in 2022, the declining light blue line helped pop the Big Tech bubble.
More importantly, with QT poised to continue in 2023, more pain should confront these behemoths, and the S&P 500 is unlikely to stay afloat if its largest constituents continue to sink.
Likewise, history shows that the post-GFC imbalances are still far from remedied.
Please see below:
To explain, the blue line above shows that the five-largest stocks in the S&P 500 from 2020 still make up 20% of the overall index. Moreover, the figure exceeds the ~18% peak from the height of the dot-com bubble.
Furthermore, when the bubble popped in 2000, the combined market cap of the millennium darlings as a percentage of the S&P 500 declined for years thereafter. Thus, while this bubble has deflated from ~24% to 20%, it’s still a long way from the 12% or less seen throughout history. As a result, Big Tech’s bloodbath should continue in the months ahead.
If we isolate the S&P 500, valuation also implies considerable downside before achieving a final low.
Please see below:
To explain, the dark blue line above tracks the Cyclically-Adjusted Price-to-Earnings (CAPE) Ratio, which uses the average of S&P 500 companies’ realized 10-year earnings, adjusted for inflation.
If you analyze the horizontal red line, you can see that the current reading of 27 remains historically high. Crucially, the relatively high readings recorded post-GFC occurred alongside stable inflation and record-low interest rates. In contrast, the lower readings from ~1900 to 2000 occurred alongside uncertain economic backdrops that rival today’s environment.
Notice how the CAPE Ratio sunk like a stone in the 1970s and nearly hit 5 in ~1980 (the red circle)? This is what happens when unanchored inflation jumps around and refuses to quit. Therefore, while a drop of that magnitude is unlikely in 2023, it still highlights why 27 is materially out of whack with the current fundamental backdrop.
So, while the silver price held up relatively well despite the S&P 500’s ~20% decline in 2022, history shows that recessions are bearish for silver, as the white metal’s high-beta behavior makes it ripe for sharp drawdowns. To explain, we wrote on Nov. 25:
While we’ve been bullish on the U.S. economy for some time, the actions required to normalize inflation should result in substantial economic weakness over the next 12 months, and economically-sensitive metals, like silver, should suffer more than gold when the tide turns.
Please see below:
To explain, the gray line above tracks the monthly movement of the silver futures price, while the red line above tracks the monthly movement of the copper futures price. If you analyze the relationship, you can see that they often follow in each other’s footsteps over the long term.
Furthermore, when the recession hit in 2001, it culminated with a ~20% decline in the silver futures price, while the 2007-2009 recession resulted in a ~46% drop, and the 2020 recession resulted in a ~23% drop. Consequently, while silver may seem like a solid momentum play when prices rise, the reversal can be just as violent on the downside.
Overall, silver has outperformed gold, bonds and the S&P 500 during this corrective upswing, but the optimism should turn to pessimism over the medium term. With the U.S. confronting a meaningful recession and the ramifications far from priced in, a dash for cash could help the silver price take out its 2022 lows in the months ahead.
Alex Demolitor
Precious Metals Strategist