Will Silver And Silver Wheaton Continue To Fall?

Includes: SLV, WPM
by: Lior Cohen

The prices of silver and Silver Wheaton (SLW) have declined in recent weeks. Moreover, the stock market hasn't performed well during October. Until Silver Wheaton publishes its third-quarter financial reports on Nov. 5, the effects of the price of silver and the stock market are likely to play a major role in the development of Silver Wheaton's stock price. What is up ahead for silver and Silver Wheaton? Let's examine the recent changes surrounding the silver market.

During the month, shares of Silver Wheaton declined by 3.7%. In comparison, the price of silver decreased by 8.1%, and iShares Silver Trust (NYSEARCA:SLV) fell by 8.4%.

The chart below presents the developments of the prices of Silver Wheaton, silver, and the S&P 500 during the year (all prices are normalized to Jan. 3, 2012). As seen below, Silver Wheaton has outperformed silver and the S&P 500 year to date. Nonetheless, these assets haven't performed well in recent weeks.

Click to enlarge images.

During October, the linear correlation between silver and Silver Wheaton remained strong and positive at 0.57. This means that, under certain assumptions (linear relation and normality of the data), nearly 32% of Silver Wheaton's stock price shifts could be attributed to the developments in the price of silver. Therefore, if the price of silver dwindles further, it could impede the progress of Silver Wheaton.

Last month's FOMC decision to launch QE3 didn't sustain the growth of the price of silver: Since Sept. 14, the price of silver fell by nearly 8.3% and Silver Wheaton by 2.8%. Nonetheless, once the QE3 program will start affecting the U.S. money base, it could start pulling up the price of silver and, by extension, Silver Wheaton. As seen in the chart below, the rise of the money base during the first half of 2011 that coincided with implementation of QE2 may have also positively affected the price of silver, which hiked during the first few months of 2011. Furthermore, the linear correlation between the changes in the money base (lagged by one period) and the average monthly price of silver is 0.37. The U.S. money base slightly declined during October. Thus, if this relation holds up, it could suggest that the price of silver, assuming all things being equal, will rally next month.

The upcoming FOMC statement isn't likely to produce any big headlines since the Fed had already made its major changes in its monetary policy in the previous meeting. Furthermore, the U.S. is still waiting for the conclusion of the presidential election in two weeks. Once the election is over, the FOMC might make changes in its monetary policy based on the results.

In the past whenever the FOMC didn't introduce any big changes in its monetary policy, the price of silver tended to fall the following day. The table below shows silver price changes on the day of FOMC statements and the following day.

The recent fall in the price of silver, and by extension the stock of Silver Wheaton, might continue in the weeks to follow. Once the U.S. election is over, the elected president could tackle the "fiscal cliff" that is affecting the stability of the U.S. economy. The shift in the news cycle toward this issue could increase uncertainty in the financial markets, which might pull up the price of silver. Finally, if the U.S. money base starts to increase (via the implementation of QE3), then this could also raise the demand for silver as a hedging investment.

For further reading, see" Will Gold Continue to Dwindle?"

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.