Was the silver price’s daily drop a one-off, or a sign of things to come?
With risk appetite taking a beating on Dec. 15, investors’ Christmas spirit seemingly disappeared before Santa Clause even arrived. As a result, while seasonality remains bullish, we warned that with the S&P 500 highly overvalued, a sharp decline could spell trouble for the silver price. We wrote on Dec. 5:
While the [S&P 500] remains elevated right now, downside risk has intensified from a fundamental, technical and sentiment perspective.
Overall, the silver price has benefited from the same false narrative uplifting several risk assets. After being shocked by 75 basis point rate hikes in 2022, the crowd believes that a step down to 50 basis points is akin to a dovish pivot. However, for those that understand history, 50 basis points are still highly hawkish. As such, the crowd is trying to create the perfect investment recipe with imperfect ingredients
Consequently, while market participants attempted to redefine a dovish pivot, the hawkish realities that upended the S&P 500 and the silver price throughout 2022 returned on Dec. 15.
Please see below:
To explain, the red line above tracks the one-minute movement of the S&P 500, while the gray line above tracks the one-minute movement of the silver futures price. If you analyze the left side of the chart, you can see that the pair jumped after the weaker-than-expected Consumer Price Index (CPI) report was released on Dec. 13.
In contrast, after Fed Chairman Jerome Powell stated the obvious on Dec. 14, it took less than 24 hours for investors to digest the fundamental ramifications. So, while we warned that the headline CPI benefited from lower oil prices and that broad-based inflation hit new 2022 highs (the Atlanta Fed’s Sticky CPIs), the fundamentals won the daily battle.
Furthermore, the connection between the S&P 500 and the silver price highlights the challenges that should confront the white metal in 2023.
For example, silver and mining stocks are more correlated to the index than gold, and with a recession poised to materialize in 2023, drastic drawdowns of the S&P 500 often sink silver. Also, with inflation anxiety still rattling the crowd, our warnings throughout 2021 and 2022 are now more noticeable.
Please see below:
To explain, Bank of America's latest Global Fund Manager Survey shows that the biggest tail risk (low probability, high impact event) is that inflation remains high. However, it's the most likely outcome. The consensus materially underestimates the resiliency of inflation, and history shows the pricing pressures do not recede along a smooth glide path.
As it stands, while inflation should slow in 2023, there is a huge difference between a sharp decline to 2% and a metric that jumps around at 5%+.
Likewise, institutional investors' beliefs contrast the medium-term fundamental backdrop.
Please see below:
To explain, the dark blue line above tracks the net percentage of respondents that expect a higher global CPI, while the light blue line above tracks the net percentage of respondents expecting higher short-term interest rates.
If you analyze the dark blue line’s sharp drop on the right side of the chart, you can see that ‘peak inflation’ is an extremely consensus opinion. Yet, declines of this magnitude often occur alongside calamities (like 2008), and the U.S. economy is far from this level of devastation.
In addition, the plight of the light blue line on the right side of the chart highlights how more fund managers are buying the notion of rate cuts in 2023.
But, that’s not how we see it. With the U.S. federal funds rate (FFR) still well below its historically-implied peak, a multitude of factors support higher short-term interest rates in 2023. So, while the silver price has benefited from the rate cut optimism, investors’ desire for pre-pandemic monetary policy should be their undoing in the months ahead.
Overall, the white metal wept as liquidations unfolded across several risk assets. However, the decline was modest relative to its recent bear market rally, which leaves the silver price well above its fundamental value. As such, with panic still missing from the financial markets, gold, silver, mining stocks and the S&P 500’s maulings likely still await us.
Alex Demolitor
Precious Metals Strategist