SLV: Bearish Headfake Is A Strong Buying Opportunity

Stuart Allsopp profile picture
Stuart Allsopp
3.58K Followers

Summary

  • The metal broke below down trendline support last week amid broad-based weakness in metals, but the downside break has since been nullified by a relatively strong bounce.
  • Silver is now trading at record low levels based on its historical correlation with gold and the commodity complex.
  • While rising U.S. real bond yields and lower gold prices are a risk, these factors have not prevented significant silver rallies in the past from similar valuation extremes.
  • The SLV has a proven track record of tracking the silver price and stands to benefit greatly if the metal recovers as the technicals and fundamentals suggest.

Silver Bullion Bars and Price Chart

Olivier Le Moal/iStock via Getty Images

I do not usually put too much emphasis on technical analysis, particularly support and resistance lines on charts, but the setup for silver looks very interesting here. The metal failed to confirm its break below trendline support which suggests upside risks dominate. Silver is also now trading at the most extreme discount to gold and the commodity complex on record by my calculations.

The outlook for silver makes the iShares Silver Trust (NYSEARCA:SLV) a strong buy in my view. The ETF which has tracked the spot price with a median 12-month tracking error of just 0.48%, should continue to offer investors direct exposure to the metal. With an expense fee of 0.50%, this is far lower than the spreads on buying the physical metal. SLV is the largest and most liquid silver ETF, but has a slightly higher expense ratio relative to others such as the Aberdeen Standard Physical Silver Shares ETF (SIVR).

False Downside Break Suggests Upside Reversal

Silver has now retraced 50% of its March 2020-January 2021 bull market, having fallen 32% from its peak at the recent lows. The metal broke below down trendline support last week amid broad based weakness in metals, but the downside break has since been nullified by a relatively strong bounce. False breaks are often strong technical indicators of a trend change as trend following traders reverse their positions.

Spot Silver price chart

Spot Silver Price (Bloomberg)

When we add in the hold above the January 2016 highs and the break above short-term down trendline resistance, the balance of risks seems to strongly favor upside now from a technical perspective.

Silver Deeply Depressed Relative To Gold And Commodities

The positive technical set up alone would not necessarily warrant a bullish position on the SLV but the fundamental outlook for silver is even more compelling. Silver is now trading at record low levels based on its historical correlation with gold and the commodity complex as the chart below shows. The strong correlation reflects silver's role as a monetary and industrial metal, and I see little reason to believe it will not remain intact over the long term.

Silver vs fair value estimate

Bloomberg, Author's calculations

It could be argued that the still-elevated level of the Bloomberg Commodity Index is down to high oil prices which reflect near-term shortages rather than strong industrial demand. This would justify some underperformance in silver relative to the commodity complex. However, the current degree of underperformance is too large to ignore. The metal is as undervalued in this metric than it was overvalued at its 2011 peak, from which it lost almost three quarters of its value over the next few years.

Can Silver Rally If Gold Weakens?

In a recent article on gold mining stocks (see 'GDXJ: Not Adding To Positions Despite Recent Weakness') I made the case for further near-term downside in gold prices due to the ongoing rise in real bond yields. This of course poses a downside risk to silver too as the opportunity cost of holding silver as a store of value has risen. However, there have been several periods in the past when silver has shrugged off rising real yield, such as the period from 2003 to 2007.

Silver vs Us inflation-Linked Bond Yields

Silver Vs US Inflation-Linked Bond Yields (Inverted) (Bloomberg)

This raises the question as to whether silver can rally even if gold prices were to decline. Historically weak gold prices have tended to be bearish for silver as one might expect. However, silver gains amid gold weakness is not without precedent. From March 1993 to February 1998 silver more than doubled in value even as gold prices fell by around 15%. Interestingly, when this period of silver outperformance began, the gold-silver ratio was at a similar level to where it is today.

Silver vs gold

Silver Vs Gold (Bloomberg)

Continued Tightening Should Not Be Taken For Granted

Another supportive factor is the ongoing rise in U.S. money supply and government debt. While the cost of money has been rising amid the Federal Reserve's tightening cycle, the volume of money in the economy continues to rise. While M2 growth has just dipped below 10%, it remains historically elevated, while the Fed's balance sheet is still expanding. As long as the government continues to run large fiscal deficits, the Fed will face significant pressure to continue buying government debt. With recession risks heightened, we could easily see wider deficits and a reversal of Fed tightening send real bond yields back down over the coming months.

Summary

Silver looks increasingly likely to have bottomed from a short-term perspective and the long-term valuation outlook is compelling. While the recent rise in real borrowing costs has undermined the case for silver as a store of value, further tightening is by no means guaranteed, particularly with the economic outlook deteriorating. The SLV has a proven track record of tracking the silver price and stands to benefit greatly if the metal recovers as the technicals and fundamentals suggest.

This article was written by

Stuart Allsopp profile picture
3.58K Followers
I am a full-time investor and owner of Icon Economics - a macro research company focussed on providing contrarian investment ideas across FX, Equities, and Fixed Income based on Austrian economic theory. Formerly Head of Financial Markets at Fitch Solutions, I have 15 years of experience investing and analysing Asian and Global markets.

Disclosure: I/we have a beneficial long position in the shares of XAGUSD:CUR either through stock ownership, options, or other derivatives. 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.

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