Will Silver Keep Heating Up?

| About: iShares Silver (SLV)

The price of silver rose during last week and reached its highest level this year. Will the silver market continue to rally? Let's examine the recent news that may affect the price of silver (NYSEARCA:SLV).

The recent recovery of the price of silver has reflected in the rise in demand for silver ETFs such as iShares Silver Trust. During February, the Silver Trust's price increased by 13.6%, and the amount of silver in the Trust rose by 1.5% to 164.24 tons. Silver-related investments such as Silver Wheaton (NYSE:SLW) also rallied during this month - the stock is up by 19%, up-to-date. Looking forward, the changes in the U.S. dollar, gold price, and the FOMC's policy could be among the factors affecting the direction of silver. Let's further explore these factors.

The Fed's policy and silver

The decision of the FOMC to taper QE3 in the past two meeting has started to slowly affect the yields of U.S. long-term securities. Conversely, the price of silver doesn't seem to be affected by the FOMC's mini-taper. Silver and U.S. long-term securities are considered safe haven investments. But the demand for silver as an investment hasn't diminished, even though the market sentiment seems to have shifted towards risk seeking. The chart below shows the movement of the price of silver and U.S. 10-year treasury yields during February.

Source: U.S. Department of Treasury and Bloomberg

As you can see, the FOMC's decision to taper again QE3 back at the end of January seems to have slightly pulled up long-term yields. But this decision didn't slow down the recovery of silver. In the past, U.S. long-term treasury yields and silver price had a strong negative correlation, i.e. as the price of silver rises, U.S. LT treasury yields tend to fall. In recent weeks, however, the correlation between the two prices was weak and positive. This finding suggests that while the last mini-taper may have reduced the demand for U.S. long-term treasuries, as it should have, it didn't slow down the recovery of silver. Thus even if the FOMC continues to taper QE3 in the coming months, it won't adversely affect the price of silver.

The developments in the foreign exchange markets could also affect the price of silver.

Silver and foreign exchange market

During last week, the US dollar slightly depreciated against Euro but rallied again the Aussie dollar and Japanese yen. The chart below shows the linear correlation of the daily percent changes of silver and leading currencies pairs during February.

Source: Bloomberg

As you can see, the linear correlation among Euro/USD, AUD/USD and silver are mid-strong. These relations suggest, assuming all things equal and under certain assumptions, if the US dollar resumes its downward trend and falls against the Euro and the Japanese yen, this could pull up the price of silver. The upcoming U.S. reports including GDP for the fourth quarter, core durable goods and new home sales could affect the direction of the U.S. dollar. If these reports show a slow down in the progress of the U.S. economy, they could drag further down the U.S. dollar, and thus positively affect silver. Despite the recovery of both silver and gold during February, it seems that the effect of gold on silver has diminished in the recent weeks.

Gold and silver

In previous months the prices of gold and silver were strongly linked. But during February, the correlation between the two precious metals has weakened. The chart below shows the linear correlations of the daily shifts of gold and silver prices during 2013 and 2014.

Source: Bloomberg

As you can see, in February 2014, the linear correlation between silver and gold was at its lowest level. Therefore, even if gold continues to recover at a slower pace than silver, the weaker correlation might suggest that silver won't necessarily follow by a similar pace.

Bottom line

Based on the above, I think silver may continue to slowly rally in the coming weeks. Even if the FOMC announces next month it will taper again QE3, this decision could have little adverse effect on the price of silver. Finally if the US dollar resumes its downward trend, it could also benefit the silver market.

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.