Stock Market Outlook: Silver Signaling Danger Ahead

by: Eric Parnell, CFA

Silver keeps breaking down. While this is a frustrating trend for those allocated to the white metal, it is far more disconcerting for the stock market outlook.

The fundamental thesis for owning silver (NYSEARCA:SLV) certainly has not changed, which is hard asset protection against aggressive monetary stimulus, pricing instability and currency debasement. If anything, this thesis has actually strengthened in recent weeks, as the situation remains tenuous in Europe and the global monetary printing presses are now either running full steam (the ECB) or set to crank up at a moment's notice (the Fed).

Ever since U.S. policy makers moved toward a weak dollar policy in early 2002, silver has performed exceedingly well. Over the past decade, the price of silver has consistently risen to post a total gain of nearly +600%. And while it endured a few short-lived fits along the way that come with the territory of owning silver, only once did it experience a sustained and prolonged pullback of any notable magnitude. And it was this past episode that may be telling of what might be lurking around the corner for stocks as we enter the New Year.

At present, silver is trading at a price that is both -10% below its 50-day moving average and -20% below its 200-day moving average. This has essentially been the case since right before Christmas on December 14.

Click to enlarge

Only once in the last decade has silver shown a similar degree of weakness. After moving sharply higher throughout much of the first half of 2008, silver began breaking down in August 2008. By August 15, silver was trading more than -10% below its 50-day moving average and -20% below its 200-day moving average. Starting only a month later, Lehman Brothers declared bankruptcy, Washington Mutual failed, liquidity markets seized up and the stock market entered into the first of three cascading declines in early October.

The fact that silver is acting in a similar fashion today is a troubling sign. First, we have seen persist indications that liquidity markets have been seizing up in recent weeks, particularly in Europe. Also, Italy is facing several major sovereign debt refinancings starting next month, which may be difficult to complete with 10-year Italian government bond yields still hovering around 7% despite already extraordinary assistance and during the relative quiet of the end of December trading week. In addition, the potential also looms for the failure of a major financial institution that could spark the similar contagion effects that we witnessed in 2008. And unlike Lehman in 2008 and more like Credit-Anstalt in 1931, global policy makers may lack the firepower to squelch the blaze this time around. These are just a few of the many risks overhanging the market at present.

With all of this being said, perhaps the weakness in silver this time around is just an isolated event. But the fact that it is occurring during a period of similar global financial stress should be noted and monitored closely at a minimum as we move into the New Year.

Given the potential risks, investors may be well served to use recent market strength to dial down risk exposures in their stock allocations. And it may be best to concentrate any remaining positions in higher quality defensive names with U.S. focused businesses. Included among these are J.M. Smuckers (NYSE:SJM) and WGL Holdings (NYSE:WGL), both of which held up considerably better than the overall stock market during the 2008 crisis.

Looking beyond stocks, U.S. Treasuries continue to provide an attractive safe haven. This includes U.S. Treasury Inflation Protected Securities (TIP), which provide a safety destination during periods of crisis as well as protection against any inflationary concerns over rampant money printing in the months ahead.

On the topic of further monetary stimulus, Agency MBS (NYSEARCA:MBB) also offer appeal as it is the likely focus of any QE3 program initiated by the U.S. Federal Reserve. Lastly, gold (GLD, IAU, PHYS) and silver (SLV) provide both a potential safe haven against crisis as well as potentially strong upside in the event of further aggressive global monetary policy actions. And since both appear to be leading indicators of the potential shocks ahead for the stock market, the downside moves in these precious metals may also be entering the advanced stages at this time.

This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.

Disclosure: I am long SLV, SJM, WGL, TIP, MBB, GLD.