Silver has broken conclusively through several important levels of resistance in recent days and looks set for a potentially parabolic rise higher as we saw following the break of the $20 level a decade ago. There are a number of similarities to the late 2010 period, with Fed easing in full swing, gold prices elevated, and the broad commodity complex trending higher. Furthermore, real interest rates are now much more deeply negative, silver prices are considerably lower in real terms, and our fair value model is suggesting there is 15% upside for the metal even in the absence of any fundamental improvements. While the surge in the iShares Silver Trust ETF (NYSEARCA:SLV) holdings is a contrarian warning signal, we do not see this as a major obstacle for further silver gains, and we maintain our view of a return to the $30 level over the coming quarters as noted in mid-March (see ‘The Coming Stagflation And The Case For Silver‘).

Spot Silver: Major Neckline Break

Source: Bloomberg

Bullish Break Reminiscent Of Late-2010 Rally

As we noted last week (see ‘SLV: Key Resistance In The Crosshairs‘), the break above the down trendline resistance from the September high has seen silver prices pick up momentum, allowing the key neckline resistance area going back to 2014 to give way, as well as the $20 level. We now see growing potential for a repeat of the parabolic rise seen in 2010-2011, which saw prices more than double over the following year. The July 2016 high of $21.14 is the next upside target which looks under threat in the immediate term, while we should expect the $19 area to offer support in the event of a pullback.

Fed Easing More Aggressive Than 2010, Supporting Real Money Demand

The primary driver of the rise in silver prices over recent months has been the expansion of the Fed’s balance sheet and sharp drop in real bond yields. The 10-year inflation-linked bond yield now sits at -88bps versus +100bps a decade ago, and with exploding government debt necessitating continued financial repression, the risks appear weighted to the downside for real interest rates and bond yields.

Silver Vs U.S. 10-Year TIPS: Silver’s Monetary Credentials Shining

Source: Bloomberg

This should be good news for gold which continues to stair-step higher as the uptrend solidifies. Elevated gold prices provide support to silver as they reflect an increase in demand for real money of which silver has a number of key credentials. The chart above shows the close correlation between silver and 10-year inflation-linked bond yields, reflecting silver’s importance to investors as a store of wealth.

Industrial Recovery Taking Shape

Silver’s industrial use means that the metal tends to also move closely in line with the price of the broad commodity complex. While silver’s monetary appeal has seen the metal rally far in excess of the rest of the commodity complex (CCI), the latter’s rise in nonetheless a supportive factor for silver prices as was the case in 2010. The strong rally in the industrial metals index in particular suggests that recovering economic activity should support silver’s industrial demand.

Short-Term Fair Value Still 10% Above Current Levels

Owing to silver’s joint monetary and industrial demand, the metal has closely tracked an equally weighted basket of the continuous commodity index and gold prices over the past 20 years (see ‘SLV: Bull Market Material‘). While the recent gains in silver have closed the gap between the spot price and our measure of fair value, there is still 10% further upside for the metal on this metric. This implies that we should see 10% gains in the metal if historical trends remain in place, even if we do not see further increases in gold and the CCI.

Silver Vs Short-Term Fair Value Estimate: Still Room To Play Catch Up

Source: Bloomberg, Author’s calculations

Money Supply Growth Still Outstripping Price Gains

We could, of course, see the basket of gold and commodity prices in the above chart decline and ‘catch down’ to current silver prices. However, we think the ongoing surge in money supply should lift the prices of commodities across the board. Despite the doubling in silver prices since the March lows, it remains down on the year when measured relative to the U.S. money supply, which has grown by a staggering 20% over this period. Ultimately, the rise in the money supply should result in a general rise in prices across the board. In fact, gold’s rally far in excess of the commodity complex in large part reflects anticipation of higher commodity and consumer prices in the future.

Silver Adjusted By CPI And M2: Still Deeply Depressed In Real Terms

Source: Bloomberg, Author’s calculations

Surge In SLV Holdings Is A Marginal Headwind

One factor which slightly detracts from the otherwise bullish fundamental and technical picture is the fact that SLV ETF holdings have absolutely exploded higher over the past four months, reflecting a rise in investment demand. The chart below shows how SLV’s market capitalization has risen much faster than its price as its physical holdings have risen.

SLV ETF Vs. Market Capitalisation: Explosion In Investment Demand

Source: Bloomberg

While rapidly increasing investment demand may seem like a reason to be bullish, it is important to note that this rise has already taken place. The future outlook for financial assets tends to be stronger when investment sentiment is negative as even a slight improvement in fundamentals can cause prices to rise. Put another way, it would be much more bullish for silver if the recent strong rise in investment demand still lay ahead of us. This is not to say that we won’t see a continued increase in investment demand, and in fact, we think the bullish break will trigger more inflows, but the rise in investment demand is certainly something to watch out for given its tendency to rise prior to market peaks.

 

Disclosure: I am/we are long SLV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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2020-07-22