While the S&P 500 waved the daily white flag, silver continued to fend off the bears.
Silver sidestepped the S&P 500’s volatility on Dec. 6, as even a collapse in the crude price wasn’t enough to wreck the white metal. However, with the PMs misjudging the fundamental backdrop, resilient inflation and a higher FFR should wreak havoc on the silver price in the months ahead.
For example, the crowd assumes that a small deceleration in inflation means the battle is over. But, it’s normal for the metric to retreat somewhat when asset prices decline. As a result, when the Fed’s hawkish actions spooked market participants, the negativity helped.
In contrast, with financial conditions loosening materially in recent weeks, higher asset prices are bullish for inflation. So, the fundamental issues that plagued the silver price throughout 2022 are far from resolved.
Please see below:
To explain, the blue bars above track the weekly change in the average U.S. gasoline price. If you analyze the right side of the chart, you can see that the metric has declined each week since early November; and with lower oil & gas prices reducing headline inflation, the developments are viewed as positive.
Likewise, with supply chains normalizing and commodity prices stabilizing, the developments have also eased the burden on U.S. manufacturers.
Please see below:
To explain, the yellow and blue lines above track the results from the Institute for Supply Management’s (ISM) Manufacturing PMI, where respondents remarked whether commodities were in short supply and increasing in price.
If you analyze the right side of the chart, you can see that both lines have declined dramatically and are well within or near normalized levels. As such, it’s another example of how supply-side inflation continues to ease.
On top of that, Drewry’s World Container Index shows that shipping prices have plunged in 2022, and the red boxes below highlight how rates from Shanghai to Los Angeles and New York have fallen by more than 60% year-over-year (YoY).
Please see below:
Source: Drewry
Wait, isn’t all of this bullish for silver and bearish for the FFR?
Well, while supply-side progress is easy to see, output inflation has not declined to the same magnitude. To explain why, we wrote on Dec. 1:
The San Francisco Fed attempted to decompose the drivers of the core Personal Consumption Expenditures (PCE) Index’s YoY increase. The blue, white and orange lines above represent supply, demand and ambiguous inflation.
If you analyze the right side of the chart, you can see that the white line (demand) has now surpassed the blue line (supply) as the primary driver of inflation. Thus, while supply chains have normalized and shipping rates have declined by upwards of ~80% YoY, output inflation has barely budged. As such, resilient demand has been the culprit, and the crowd doesn’t grasp how difficult this will make the Fed’s job in 2023.
To that point, while the Cleveland Fed reduced its projections for the headline Consumer Price Index (CPI) in November and December (due to lower oil prices), the core CPI has barely budged.
Please see below:
Source: Cleveland Fed
To explain, the Cleveland Fed expects the headline CPI to increase by 0.47% and 0.37% month-over-month (MoM) in November and December. In contrast, the core CPI is expected to increase by 0.51% MoM in both months, and the YoY figures should surpass 6%.
Therefore, while normalizing supply-side pressures help reduce the headline CPI, record-high household checkable deposits and wage inflation keep demand high for core CPI items outside of food and energy. Likewsie, we noted on Sep. 14 that lower commodity prices would only free up more cash for Americans to spend on discretionary items. We wrote:
The CPI outperformed expectations across the board. Furthermore, we warned that while lower oil & gas prices were bearish for the headline CPI, the rise in Americans’ disposable income was bullish for the core CPI. Thus, it’s no surprise that the latter increased from 5.9% YoY in July to 6.3% YoY in August. As a result , the supply-side theorists are still scratching their heads because they misunderstand the resiliency of consumer demand.
So, while the consensus continues to highlight the supply-side metrics that signal lower inflation, we don’t disagree with the arguments. Yet, the demand-side has been dismissed throughout this bout of inflation, even though it’s the primary reason why progress has been so slow.
Consequently, with U.S. retail sales hitting an all-time high in October and Mastercard’s SpendingPulse report also bullish, demand remains resilient; and with average hourly earnings (wage inflation) coming in more than double the consensus MoM estimate in November, Americans still have plenty of spending power.
Overall, while the silver price’s strength makes it seem like a dovish pivot is a done deal, don’t be surprised if the peak FFR is higher than the ~5% currently expected.
Alex Demolitor
Precious Metals Strategist