Introduction

Silver (NYSEARCA:SLV) prices have rallied significantly in the past two months, up over 50% from their March lows and slowly approaching the high of their five-year range of 13.5-18.5. In addition, SLV has also been trading above its 200-day simple moving average (SMA), comforting investors that we may be experiencing the start of a long-term rally. In this article, we argue that even though we remain bullish on SLV in the long run, we think that silver looks quite vulnerable in the short run and we expect a little consolidation in the coming weeks.

Figure 1

Source: Eikon Reuters

Silver seasonality: June is the worst month

Historically, we know that stocks’ performance has been significantly lower in the summer period from May to October than in the winter period between November and April. In a recent article, we extended the “sell in May and go away” investment adage to different asset classes and found some interesting results for silver. Unlike gold and other safe such as the Japanese yen, silver tends to perform poorly in the summer period. In Figure 2, we compute the average returns for silver for each month of the year since 1982; interestingly, silver’s worst performing month has historically been June, with the precious metal falling by nearly 2 percent on average. Hence, bullish investors may want to avoid a potential depreciation in June, especially now that SLV is strongly “overbought” according to the RSI.

Figure 2

Source: Eikon Reuters, RR calculations

SLV drivers

As for gold (NYSEARCA:GLD), real interest rates have been one of the main drivers of SLV over time; figure 3 (left frame) shows that the collapse in the 10Y US real interest rates from 1.20 to nearly -0.50 has been levitating the price of most of the non-interest-bearing assets such as gold, silver or even Bitcoin (BTC). As silver does not generate any cash flow and investors benefit only from the capital appreciation, it is very sensitive to the dynamics of real interest rates. The other major driver is obviously the US dollar (NYSEARCA:UUP). In general, commodities perform poorly when the USD strengthens sharply.

We do not expect the USD to strengthen significantly in the coming months, but we do expect UUP to remain strong as we believe that the US growth will outperform most of the economies post lockdown. The lack of “solidarity” in the euro area combined with the Brexit uncertainty will weigh on both economies, which will decrease the real GDP growth differential relative to the US and therefore weigh on both currencies (euro and sterling).

Figure 3

Source: Eikon Reuters

SLV: Not so much “zero-beta”

In the long run, we saw that silver tends to be a good hedge against volatility and rises when the VIX starts to surge. Figure 4 (left frame) shows that in the past 30 years (since the VIX inception), silver has performed positively when the VIX was trading above 20, averaging 45bps. It is still far from the 80bps performance in gold, but it has been a solid diversifier in periods of market stress. However, we can notice that it performed terribly in the first quarter of 2020, falling by 21%, and has co-moved perfectly with US equities (figure 4, right frame). We know that inertia – how an asset has performed in the past – is a strong characteristic when defining a “safe haven” asset, and therefore silver may be more sensitive to a downside move in equities coming forward. Price volatility has been compressed across all asset classes mainly due to the massive central banks’ interventions, but uncertainty (or fundamental volatility) has been constantly rising in the past two months. Hence, we strongly believe that the divergence between uncertainty and volatility in the medium term makes US and international equities more vulnerable to a little 10 to 15 percent selloff and could significantly impact silver prices again.

Figure 4

Source: Eikon Reuters, RR calculations

Silver does not always follow gold’s moves

According to some analysts, silver remains extremely undervalued relative to gold prices and therefore should continue to appreciate in the medium term, which should bring the ratio to its long-term “equilibrium”. Figure 5 (left frame) shows that indeed the gold-to-silver ratio has broke out of its LT 35-100 range and surged to over 120 during the March divergence; however, we argue that this ratio will certainty become less relevant in the future and we could have a sustained period of gold strength while silver remains steady, levitating the ratio to a higher range.

One of the main difference between gold and silver is that investors can actually trade gold as a macro investment (hedge against uncertainty or inflation, currency…) and completely ignore the supply and demand dynamics, while we think that the silver market requires more attention to the supply/demand dynamics due to its elevated industrial use.

Figure 5 (right frame) also shows that the so-called “silver follows gold rally” belief can be suddenly broken by a new market regime. For instance, in the past five years, we can notice that gold rallies were followed by a surge in silver prices three weeks later; hence, traders were using prices of gold to trade silver regardless of the dynamics in the silver market. However, the relationship broke down during the February March selloff.

Figure 5

Source: Eikon Reuters

SLV short-term outlook

To conclude, we think SLV could experience a ST consolidation after the strong recovery in the past two and a half months. Figure 6 shows that SLV is currently trading slightly above 16.6, which corresponds to the 76.4% Fibo retracement of the 10.85-18.35 range and is slowly approaching its LT downward trending resistance. We will start shorting some at 17.5 with a first target at 15.8 (200D SMA), keeping a stop above the SLV 2019 high at 18.50. In addition, the RSI is also indicating that SLV is strongly “overbought”, which makes silver vulnerable to little consolidation, especially now that we are entering the month of June.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in SLV over the next 72 hours. 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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2020-05-31