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Silver remains unfazed by the equity turmoil, for now

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Much like its big brother gold, silver has had a muted response to the recent stock volatility. Not only has the metal not rallied, it has actually fallen over the past couple of weeks, even despite the sharp drops in major global equity indices. That said, the longer this uncertainty and the turmoil last, the more likely it becomes that investors will seek the safety of haven assets and that silver could come back into fashion.

Those looking for a list of reasons over why silver has underperformed lately need to look no further. Number one on this list is the dollar’s performance. As is the case with most other precious metals, silver is traded in US dollars. The implication is that when the greenback appreciates, investors using foreign currencies find it more “expensive” to buy the same amount of silver, which typically weighs on demand for the metal. Vice versa, when the dollar depreciates, silver gets a boost in demand. In this case, the dollar managed to find a bottom and rebound towards the end of January, when the stock volatility commenced, thereby pushing down on silver prices.

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At number two are expectations of higher future inflation and higher interest rates. The recent acceleration in US wages spooked investors that a similar acceleration in inflation may be just around the corner. While silver is broadly viewed as a hedge against inflation (as it tends to retain its value), accelerating inflation would probably lead the Fed to step on the “brakes” and raise interest rates faster, in order to reign in the inflationary pressures. Rapid rate hikes would likely be negative for silver, which pays no interest to hold and thus become less attractive in an environment where yield-bearing assets begin to offer better returns.

Finally, a theme that has gained a lot of attention recently is that the correction in stocks is “healthy”. The stock selloff doesn’t reflect pessimism regarding the economy but is rather a technical correction in overvalued equity markets. As long as it does not spill over into the broader economy via diminishing business sentiment, there is little to fear, and there is thus no need to rush into safe havens.

What happens next in silver? In the short-run, a lot will hinge on how the stock turmoil evolves. While a 10% correction in stocks is seen as “healthy”, that narrative could quickly change in case the selloff intensifies, or the volatility persists for a prolonged period. To put it in the words of New York Fed President William Dudley: “from the central banker’s perspective, this is all about magnitude and duration”. The same logic can be applied to investors considering to increase their safe-haven exposure. The magnitude and duration of the stock turbulence will probably go a long way in determining whether safe haven assets will begin to enjoy increased demand.

Another major consideration is the dollar. While the currency appears to have stabilised and to have carved out a bottom, for now, it is still in a downtrend in practically every timeframe. Should it resume its downward path, it would be a factor making silver more attractive. Conversely, if the dollar manages to recover – perhaps buoyed by a hawkish Fed – that would probably exert downward pressure on silver.

Technically, the precious metal has been trading within a symmetrical triangle formation since April. Should the stock market turbulence intensify, or if the dollar comes back under selling pressure, then silver may be rebound. A potential upside break of the $16.85/ounce resistance level could open the way for the crossroads of the $17.60 level and the upper bound of the aforementioned triangle. On the other hand, in the scenario that equity markets stabilise or the dollar stages a comeback, silver could drift lower and possibly break the $16.20 support and the lower bound of the triangle. Such a break would be a bearish signal and could increase the likelihood of even further near-term declines, initially towards the $15.60 level.

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This information is not considered as investment advice or investment recommendation but instead a marketing communication. This material has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and that it is not subject to any prohibition on dealing ahead of the dissemination of investment research.

source: XM

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