The hype over the Fed's decision to commence QE3 seems to have subsided, for now, as the bullion market has cooled off in recent days. The focus has shifted back to Europe, which seems to affect not only the euro, but commodities prices as well, including silver and gold. During September, shares of Silver Wheaton (SLW) rose by nearly 9.9%. In comparison, the price of silver also increased by 8% during the month. iShares Silver Trust (SLV) also rose by 6.1%. Most of the rise in silver and silver stocks occurred up until September 13 -- the day of the QE3 announcement. Will silver and Silver Wheaton resume their rally in the near future? Let's examine the recent developments adjacent to the silver market.
The chart below shows the normalized prices of Silver Wheaton, silver prices and the S&P 500 (prices are normalized to August 31, 2012). As the chart illustrates, Silver Wheaton's stock and silver price rose up until September 13 following the QE3 announcement. Since then, however, the prices of silver and Silver Wheaton have dwindled.
(click images to enlarge)
During the past several weeks, the linear correlation between silver and Silver Wheaton reached 0.79. This means, under certain assumptions, nearly 63% of the stock's recent rally could be explained by the recovery of silver. In other words, besides Silver Wheaton's business developments and good financial results during the second quarter, the price of silver is another prime contributor to the company's recovery. Therefore, if silver doesn't 't resume its rally, it could result in a pullback in Silver Wheaton as well.
So what is next for silver? Let's break down the recent developments in the three main economic areas -- the U.S., Europe and Asia:
There are reports that, despite the slow progress in the price of silver in recent days, ETPs continue to raise their bets on silver. My guess is that some traders cut their exposure following the sharp rally in the price of silver, which may explain the slight decline in silver prices.
There are concerns over the Fed's recent QE3 plan, and whether it will actually help rally the U.S economy. Federal Reserve Bank of Philadelphia President, Charles Plosser, stated in a recent speech: "We are unlikely to see much benefit to growth or to employment from further asset purchases."
This isn't exactly a vote of confidence in the Fed's plan, and it may have contributed to the appreciation of the U.S. dollar.
Keep in mind, if there isn't a substantial improvement in the U.S. economy (e.g., manufacturing, labor, etc.) in the near future, the Fed could and would, according to the recent statement, introduce additional policy tools to jump-start the economy:
If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.
Therefore, if the Fed will introduce additional policy steps (perhaps raising the target inflation, intervening in the forex market to depreciate the U.S. dollar, etc.), it could help rally the price of silver.
One of the main economic issues in Europe in recent days revolves around Spain. The ECB and Germany are still waiting for Spain to make its request so that ECB can start its bond purchase program. Spain is still reluctant to do so, and as a result, its long term yields have recently increased above 6%. There is also political instability in Spain as Catalonia seeks independence, which raises additional uncertainty in the country. In Greece, there are protests around budget cuts. The talks over the third bailout program may have also contributed to the weak euro and raised the demand for U.S. long-term bonds.
The U.S. long-term bond market reacted very promptly to the QE3 decision, but since September 14, the long-term yields have declined, perhaps over concerns around the euro debt crisis.
As seen in the chart below, in recent days, both silver and U.S. 10-year notes yield have declined. Even though the relation between the two fluctuates, it could suggest that the risk aversion sentiment has prevailed in recent days.
Bank of Japan announced last week it will expand its stimulus plan by 10 trillion yen ($126 billion). This news, however, didn't seem to affect the Japanese yen, but implies that the Japan's economy is still not doing well.
China is not showing signs of recovery, as the manufacturing PMI is still below the 50 point mark. The slow progress in Asia is also likely to keep pulling down commodities prices, including gold and silver prices.
I think the Fed's QE3 is likely to keep the price of silver high, and if the Fed introduces additional steps, it could apply more upward pressure on silver and silver stocks. Nonetheless, for the near future, the developments in Asia and Europe could continue to curb the progress of bullion.
For further reading, see "Gold and Silver Report for September 24-28".