Will Silver Change Direction?

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 |  About: iShares Silver Trust ETF (SLV), Includes: SLW
by: Lior Cohen

The price of silver continued to rise in the past couple of weeks and reached its highest level since November 2013. Will the silver market continue to heat up or will it slow down? Let's analyze the recent news that may affect the price of silver (NYSEARCA:SLV).

The rally of silver has reflected in the increase in demand for leading silver ETFs such as iShares Silver Trust. During this month, the Silver Trust's silver price increased by 12%, and the amount of silver in the Trust rose by 1.1% to 163.63 tons. Silver related investments such as Silver Wheaton (NYSE:SLW) also recovered during February - the stock is up by 17%. This week, the minutes of the FOMC meeting might have a short term effect on the price of silver. Let's further explore this issue.

FOMC's monetary policy and silver

Janet Yellen, the Chair of the FOMC, testified last week on the Hill regarding the FOMC's monetary policy, in which she voiced her concern over the progress of the U.S labor market. Moreover, the U.S's economic progress has slowed down in recent months; this, combined with the current low inflation - below the Fed's target, could eventually lead the FOMC to reconsider its policy. After all, the FOMC has additional ways to jump-start the economy, if needed, such as raising its inflation target or pegging long term interest rates. But let's not get too ahead of ourselves.

For now, the slow descent in the rate of unemployment is likely to maintain the FOMC on track by tapering further QE3 in the coming months. The minutes of the last FOMC meeting will come out this week. They could offer some insight behind the FOMC's next decision on tapering QE3 and the future steps the Fed may take. If the minutes reinforce the speculations of the FOMC's plans to taper again QE3 in the next meeting, this could have some adverse short term effect on the price of silver as it did in previous meetings.

Following the last decision of the FOMC to cut down its asset purchase program, silver bounced back within days. This could suggest that tapering QE3 hasn't slowed down the rise in demand for silver. Thus, even if the FOMC continues with these mini-tapers in the coming months, they might not have any long term adverse effects on the price of silver. Let's see why.

(click to enlarge)Click to enlarge

Source: Federal Reserve and Bloomberg

The chart above shows the developments in the U.S money base and the average price of silver between 2012 and 2014. As you can see, the increase in the U.S money base - a result of the asset purchase program - didn't pull up the price of silver. Therefore, this could also imply that tapering QE3 won't have a negative effect on silver. In the past several months, since it became clear the Fed will start taper QE3, the price of silver didn't move much and slowly recovered. This trend is likely to persist as long as the Fed maintains its low short term interest rates.

The developments in the foreign exchange markets could have some effect on the progress of the price of silver.

Silver and US dollar

The recent depreciation of the US dollar against leading currencies such as Euro and Japanese yen may have also helped pull up the price of silver. The chart below presents the linear correlation of the daily percent changes of silver and leading currencies pairs.

(click to enlarge)Click to enlarge

Source: Bloomberg

As you can see, the linear correlation between Euro/USD and silver is mid-strong and positive, and between USD/Yen and silver is mid-strong and negative. These relations suggest, assuming all things equal and under certain assumptions, if the US dollar depreciates further against the Euro and the Japanese yen, this could pressure up the price of silver.

Final note

Based on the recent developments, I think silver's rally might slow down in the near future. This week's publication of the minutes of the last FOMC meeting could revisit the debate over the FOMC's next taper, which is currently likely to occur in the near meeting. Finally, the progress of US dollar could also play a secondary role in affecting the price of silver.

For further reading see: Is This Gold Producer a Buy?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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.