Silver Proves No Port In The Storm

With all the talk of a renewed period of risk-aversion in financial markets, it is important to know where to park funds versus the strategic pitfalls that can be made as conditions shift. The same instruments that benefited during the last market crisis might not have the same form of appeal in the present day owing to a host of different factors. Precious metals in particular have only seen the carnage increase as the outlook worsens in one stark example of how the flight-to-safety trade is evolving amid the turmoil sweeping through global markets. Silver in particular has been one of the hard hit assets and as conditions worsen, do not expect that prices will suddenly improve even as investors consider ownership of hard assets in lieu of financial instruments.

The Fundamental Picture

In general, precious metals are non-productive assets. They have limited practical application to industrial processes and mainly serve as a store of value and wealth.  In modern times metals have become an integral component of a properly diversified portfolio but the status of precious metals prevents them from having more practical value. The reason why precious metals are considered an excellent form of stored wealth is that they have been used as a mechanism for exchange for centuries, remaining in circulation all these years despite the proliferation of fiat currency.  Unlike a currency which is backed by the full-faith in a government and its taxation abilities, precious metals depends on the faith of users and the prevailing attitude towards paper wealth. However, in today’s marketplace, the case for ownership in present times at current levels is greatly diminished.

In the wake of the last crisis of 2009, many investors flocked to precious metals in an effort to hedge against the extreme monetary policies of central banks. The idea of adding liquidity via rapid expansion of the monetary base has been a popular tool across the globe, practiced by such famous institutions as the US Federal Reserve, the Bank of England, the Bank of Japan, and most recently the European Central Bank. The idea of expanding the monetary base means that each additional notional amount of fiat currency added to the money market drives down the value of the local currency. These measures are often intended to keep the currency competitive, helping to maintain export affordability and labor costs more attractive. However, the dangers of money printing and adding to the monetary base are well documented. For a keen example of the failures of money printing, the best modern example is Zimbabwe which has seen rampant hyperinflation as a result of its expansionary monetary policies.

When a nation rapidly expands the monetary base, the risk of runaway inflation rises, leaving investors no choice but to return to hard assets in an effort to hedge against hyperinflation. Looking back towards the last crisis, money managers were keenly aware of these potential forces with scores of traders adding to their portfolios in an effort to capitalize on the momentum higher.  However, after hitting the bubble territory, prices suddenly dropped steeply. The lack of inflation in global economies sapped demand for precious metals and silver in particular. Right now, a quick look at inflationary metrics in developed economies shows that these very nations are facing a pronounced risk of deflation after the epic levels of monetary stimulus that were added to the global economy. In the United States specifically, inflation sits just above the zero-bound which has led to a situation in which the US dollar and precious metals have a strong inverse correlation.

With heightened anticipation of interest rate policy normalization coming in mere months, the dollar has surged higher on expectations. This has created a significant amount of pressure on precious metals, especially silver as the uptick in the dollar translates to weak demand for the metal. As a result of recent momentum, silver prices hit the lowest level since December low yesterday in spite of concerns regarding the global economy. Even with the multitudinous factors screaming recession and the end of latest economic cycle, the silver bulls are finding their investment thesis flawed despite strong physical demand with the US Mint running out of silver bars yesterday. However, in the commodities market, silver prices are unlikely to rebound any time soon as investors clamor for the quality of the US dollar in place of other financial instruments to protect against the brewing storm.

The Technical Take

The losses in silver prices have accelerated in recent sessions as risks emanating from Greece and China have seen investors pick the US dollar, Swiss Franc, and Japanese Yen to protect against any protracted weakness in financial markets. The momentum in silver prices is unlikely to abate soon owing to a host of technical factor as well with the precious metal currently trading beneath both the 50-day and 200-day moving averages. On a longer term basis, XAGUSD also looks to be forming a descending triangle pattern, a bearish formation focused on the consolidation between a prevailing downtrend line and support.  After breaking through a major technical level approximately a year ago, silver looks to be doing more of the same at present. Another major pattern that comes to attention is the potential head and shoulders bearish pattern which also has a strong downside bias. Coupled with continued appreciation in the dollar, silver prices have much further room to fall, with levels last seen in 2009 rapidly becoming relevant.

Conclusion

Silver is not going to be buoyed by the latest round of financial instability like other financial assets.  In fact, risks are acutely to the downside for silver prices as momentum higher in the US dollar saps demand for silver prices.  A respite from the carnage may come down the road if investors begin to lose faith in power of fiat currencies.  However, until that point, the value of holding silver will continue to diminish especially with the weak inflation outlook.  Should confidence n governments fail and inflation begin to manifest itself at rates that inhibit growth, the case for owning silver and other precious metals could find itself resurrected.  However, until that point, do not expect silver to weather the coming storm.