Yvan Berthoux – 27 August 2020One of the less celebrated beneficiaries of the massive infusion of central bank liquidity over the past few months is silver: its price has enjoyed a breathless ascent to within touching distance of US$30/oz, rising by almost 50 per cent in a matter of weeks. Even considering the recent 12 per cent consolidation, silver remains the best performer this year, up over 125 per cent since its March lows. However, in a climate of increasing uncertainty over the enduring effects of Covid-19, equities trading at historical highs and an extremely oversold US Dollar, the balance of risk has soured. Beware, silver price consolidations can be fierce.
Two of the main drivers of the recent surge in precious metals prices have been the sharp decrease in real interest rates and the significant weakness in the US Dollar. Figure 1 (left frame) shows that the 5Y US real rate collapsed from zero in March to -1.25 per cent in August; in common with most non-interest-bearing assets, silver benefits in periods of falling real yields. The US Dollar has also been subject to significant downward pressure this year, especially against the other majors: figure 1 (right frame) shows that the greenback is down nearly 10 per cent since its March high of 103 amid the aggressive Fed interventions.
Figure 1
Data source: Eikon Reuters
Even though the trends look very impressive, we are sceptical of their continuation in the coming weeks, with a pause, if not a correction, in prospect. Silver prices have been lifted by the same tide of liquidity enjoyed by US equities in the past few months. Figure 2 (left frame) shows the tight relationship between the S&P500 and silver since the Covid-19 shock. Are silver bulls really hedged against a sudden drawdown in equities? It is important to know that in the first quarter, silver prices were down by over 20 per cent when equities cratered by 20 per cent, while gold was up 3.6 per cent.
Historically, we have seen that gold prices generally lead silver prices and that periods of significant gold appreciation are followed by even bigger silver trends. Looking at the gold-silver ratio, which is trading slightly above its long-term average at 66 from an extreme high of 124 in March, it seems that the silver move is done and that the probability of a little pause or even correction in the near term has been rising recently. Hence, we expect gold to offer greater resilience in the face of a seasonal challenge to current equity valuations.
Figure 2
Data source: Eikon Reuters