The bear-bull battle rages on between $18 and $24.
With the S&P 500 squeezing higher on Dec. 29, the bulls hope the index can narrowly escape a 20% decline in 2022. Although, with the dip buyers suffering another mauling, we warned on Jul. 26 that the bear market was far from over. We wrote:
With the consensus often more influenced by price than fundamentals, here are some of the headlines that hit the wire on Jul. 25:
Source: Bloomberg
The price action – combined with the S&P 500's ability to hold up despite weak economic data – has investors assuming that peak bearishness is in the past…. [But], while investors’ misguided optimism is short-term bullish for the GDXJ ETF, the medium-term realities should have the opposite effect.
To that point, with Ed Yardeni – a staunch permabull – changing his tune on Dec. 29, the hindsight crowd now understands the hawkish realities that emerge alongside unanchored inflation.
Please see below:
Source: Bloomberg
So, while the S&P 500 eventually took out its June low in September and October, we warned for many months that inflation and rate hikes would rattle the financial markets in 2022. As a result, the fundamentals unfolded as expected.
Please see below:
Source: Bloomberg
However, the important point is that 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.
For example, while the S&P 500 has suffered mightily in 2022, its year-to-date (YTD) decline has been driven by QE beneficiaries and interest rate sensitive areas of the market.
Please see below:
Source: Fidelity
To explain, the red rectangle above shows how the S&P 500’s 2022 swoon has been led by communication services, consumer discretionary, information technology and real estate. In contrast, economically-sensitive sectors – like financials, industrials, materials and energy – have only suffered mild drawdowns or rallied (like energy).
But, with the ‘old economy’ poised to feel the recessionary heat in 2023, value sectors should face the brunt of the burn.
Please see below:
To explain, the blue line above tracks the year-over-year (YoY) percentage change in the Bloomberg Commodity Index, while the black line above tracks S&P Global’s manufacturing PMI. If you analyze the relationship, you can see that when the PMI dips below 50 (contraction), it often culminates with YoY declines in the Bloomberg Commodity Index.
Yet, the latter’s outperformance on the right side of the chart shows how commodities remain abnormally elevated despite the weakness in the manufacturing sector. Consequently, with a likely recession poised to push the PMI even lower in 2023, the catch-down from commodities should hammer the silver price.
Likewise, please remember that no S&P 500 bear market has ended before a recession hit in ~100 years; and with nine of the last 10 bouts of rising inflation ending with recessions, a value-sector-led drawdown of the S&P 500 in 2023 should materially impact silver.
Please see below:
To explain, the blue line above tracks the S&P 500 (log scale), while the gray bars above represent recessions, and the red Xs represent market bottoms. As you can see, recessions push the S&P 500 to new lows, as the economic weakness overpowers dovish pivots. So, with history undefeated, we expect a similar outcome to occur before this bear market ends.
Finally, while the U.S. 10-Year real yield has quietly risen in December, the Fed’s balance sheet has quietly shrunk.
Please see below:
To explain, the Fed’s balance sheet hit a new 2022 low on Dec. 28 (updated on Dec. 29), which highlights the continued liquidity drain. Thus, with QT poised to remain a problem for risk assets in 2023, the PMs are unlikely to sidestep the volatility.
Overall, the silver price remains uplifted, as the tech wreck has elicited a bid for hard assets. However, bear markets often end with liquidations, which means that all assets are sold amid the dash for cash. In contrast, the 2022 sector rotations that occurred alongside shifting narratives highlights why the PMs’ final lows likely await us.
Alex Demolitor
Precious Metals Strategist