Will Silver Wheaton And Silver Change Direction And Fall?

| About: Wheaton Precious (WPM)
This article is now exclusive for PRO subscribers.

Shares of Silver Wheaton (SLW) continue to trade up; during September, the stock rose by nearly 4.2%. In comparison, during the month the price of silver also increased by 6.8%. iShares Silver Trust (NYSEARCA:SLV) also increased by 5.3%. The two main events of the week revolve around the decision of the FOMC meeting on another QE program, which is likely to pull the price of silver up and, by extension, Silver Wheaton. The other news item is the recent German court ruling on ESM that helped ease concerns over the EU debt crisis. Let's see what's new in the silver market that could suggest what's next for the price of silver:

  • The recent German Court ruling that decided, as many had anticipated, the ESM bailout package is legal and constitutional. That helped rally the euro/USD, and precious metals prices also increased.
  • The next step will be for Spain to officially ask for the aid. There is a summit of the EU financial ministers at the end of the week that could provide some clarity as to the future of steps of the EU regarding the debt crisis.
  • The renewed expectations of another quantitative easing that started soon after the minutes of the FOMC meeting were published at the end of August.

I have shown the strong relation between the news regarding QE3 and the movement of gold price via Google trends. It shows, as expected, a strong and positive linear correlation between the two. This find could suggest that even if the FOMC won't actually announce of QE3 but will only allude to the fact or just keep the door open on it, then gold and silver will continue to trade up -- and by extension Silver Wheaton will follow.

The FOMC meeting will conclude on Sept. 13. My guess still remains that the FOMC won't announce QE3; the U.S. is currently in an election year and without political stability and fiscal action, this plan might have little chance of actually stimulating the economy. Keep in mind that despite QE1, QE2 and the Obama stimulus package of 2009, the current rate of unemployment is only 1.7 percentage points lower than it was three years ago. According to the recent U.S. employment report, the rate of unemployment is 8.1%. This modest achievement, along with a low GDP growth rate, might eventually lead the Fed to consider other actions than QE. According to Paul Krugman, there are other possibilities the Fed could consider to stimulate the economy, such as pledging for low interest rates for long=term government bonds, raising the inflation target to 4%, or intervening in the foreign exchange market to push down the value of the U.S. dollar.

These suggested polices, some of which Bernanke himself pointed out that Bank of Japan should have tried during the early 2000s, are less likely to be considered. But if the FOMC announces one of these suggested policies, it will likely raise concerns for many investors regarding the stability and strength of the U.S. dollar -- and thus also affect the prices of gold and silver. But the strongest effect will still be QE3, especially if it is much bigger than the previous two quantitative easing programs (in dollar terms).

In the chart below are the normalized prices of Silver Wheaton, silver, and the S&P 500 (prices are normalized to July 31, 2012). As you can see, Silver Wheaton's stock and the price of silver hiked during recent weeks. Due to this rally, the stock has passed the S&P 500. The chart also demonstrates the strong correlation between Silver Wheaton and the price of silver.

During August and September, the linear correlation between silver and Silver Wheaton reached 0.60. This means, under certain assumptions, that nearly 37% of the stock's volatility could be explained by recovery of silver. Therefore, besides Silver Wheaton's business developments and good financial results for the second quarter, the price of silver is another contributor to the company's recovery.

Click to enlarge image.

Therefore, there are two issues that could affect precious metals. I still think the FOMC won't pull the trigger just yet on QE3 but might allude to it, which is likely to maintain the current price level of silver. On the other hand, the market is too invested in QE3 that no announcement might even cause a pullback in precious metals. The recent court ruling in Germany is another milestone in the process of pulling the eurozone out of its slowdown and helping the struggling countries to raise debt. This, in turn, is likely to keep the euro strong against the U.S. dollar and, consequently, the price of silver and Silver Wheaton high.

(For further reading, see "Gold And Silver Outlook For Sept. 10-14.")

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.