Has the white metal become the new consolidation king?
With silver’s disdain for $24 on display again on Jan. 24, the white metal has been unable to break through its glass ceiling. Moreover, if silver can’t showcase strength when the VIX is low and optimism is high, what will happen if (when) the backdrop reverses?
For example, famed investor Jeremy Grantham released his latest research report on Jan. 24. He wrote:
“The first and easiest leg of the bursting of the bubble we called for a year ago is complete. The most speculative growth stocks that led the market on the way up have been crushed, and a large chunk of the total losses across markets that we expected to see a year ago have already occurred…..
“My calculations of trendline value of the S&P 500, adjusted upwards for trendline growth and for expected inflation, is about 3,200 by the end of 2023. I believe it is likely (3 to 1) to reach that trend and spend at least some time below it this year or next.”
To that point, while he admits that timing is difficult due to a confluence of factors, he repeated our warning that rate cuts often occur when liquidations are already underway. Therefore, while the perception of a dovish 180 is bullish, real pivots are highly bearish. Grantham wrote:
“You should focus only on the four great U.S. bubbles. The fundamentals had so much negative momentum that for three of them (1929, 2000, 2007) the largest part of the market decline occurred after the first rate cut.
“In 1974 the market did turn up, after a horrific 62% real decline in two years, exactly as the first rate cut took place. (That rate cut was delayed by the surge in inflation caused by the infamous oil shock.)”
Thus, while he noted that a lower FFR marked the short-term bottom in 1974, it took a 62% real (inflation-adjusted) decline in the S&P 500 before the carnage was priced in. Conversely, the other major bear markets still experienced subsequent S&P 500 drawdowns of 41% to 79%.
Please see below:
So, while the crowd maintains that a new bull market has begun, valuation has Grantham’s firm GMO predicting negative U.S. equity returns over the next seven years, versus their long-term historical annual average of 6.5%.
Please see below:
To explain, the two bars furthest to the left show how GMO expects U.S. large and small caps to return -0.7% and -0.4% annually over the next seven years. Furthermore, since average returns don’t occur in small drips, periods of abnormally high and abnormally low performance often dominate; and with the U.S. market still overvalued, another sharp S&P 500 drawdown could crush silver, just like it did when the pair hit their 2022 lows in September and October.
As a result, while the physical silver market may outperform, the panic that often occurs alongside major S&P 500 drawdowns makes the silver futures price highly vulnerable. Therefore, we see many risks that are likely to occur but are far from priced in.
Overall, while the silver price awaits the next fundamental catalyst, we believe there is much more downside than upside. With CTAs highly net long the PMs, inflation showing renewed strength, and even commodity bulls like Goldman Sachs expecting a pullback to $21 over the next three months, the medium-term outlook remains profoundly bearish.
How should we interpret Grantham’s prediction? Do you think there is a 75% chance the S&P 500 will hit 3,200? How would the Fed react?
Alex Demolitor
Precious Metals Strategist