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Elliott Wave Trading

Silver Price Breaks Higher on Rising Anxiety

Commodities / Gold and Silver 2016 Jan 31, 2016 - 03:52 PM GMT

By: AnyOption

Commodities Echoing the perilous financial market volatility of late, silver prices have gradually moved to the highest levels since December as growing risk aversion and shifting sentiment see safety bids gain momentum.  While not necessarily indicative of a resumption of the trend higher that began in the depths of the last financial crisis, several factors are pointing to increased potential gains in the precious metal as investors are forced to pivot from yield to quality in an effort to hedge against ongoing turmoil.  While inflation may remain low, dragging on prices over the medium-term, tightness in the physical supply chain alongside increased interest in hedging against uncertainty of monetary policy and central banking continue to contribute to upside in silver.


Surging Volatility Stokes Safety Bid

The worsening fundamentals inherent in the Chinese economy combined with an ongoing deterioration in global trade has sent investors fleeing back to the safety of precious metals as the early phases of the storm look to be upon financial markets.  In general, financial market instability and greater political uncertainty contribute to a risk premium in silver prices.  While difficult to quantify the actual numerical impact of risk aversion, it is understandable that during periods of greater intervention, silver typically responds positively as investors demand wealth preservation to offset the possibility of widespread depreciation in financial instruments.  However, silver prices do not necessarily always go up in times of turmoil as evidenced by the last financial crisis when prices fell.

Volatility in financial markets is not forecast to abate in the near-term as Chinese policymakers work tirelessly to prevent sustained capital outflows and keep markets stable by increasingly injecting liquidity to keep rates from spiking.  However, as returns for equities and other asset classes become more volatile and the Yuan is devalued further, the incentive for owning and holding physical precious metals has increased dramatically, stoking buying pressure on the physical side as citizens look to preserve their wealth.  Outside of China, demand for precious metals is equally on the rise as evidenced by soaring premiums and regular shortages at mints.  With uncertainty on the rise, the bid in precious metals continues to reflect sentiment and the desire to store value.

Physical and Paper Dislocation

Amid rising bids for silver futures, it is important to recall a relevant phenomenon from the past year; premiums to purchase physical silver are surging.  Depending on the source of data, some buyers are currently experiencing premiums of anywhere between 20-30% and in some cases as high as 81.38% for physical coins versus paper contracts, underlining issues in the supply chain for silver.  Key producing nations saw output fall during 2015, with US production shrinking by -6.50%, followed by a -4.60% decline in Chile and a contraction in excess of -20.00% in Canada.  While part of this may be attributable to the cash cost of extraction falling below breakeven costs, it could also be indicate increased difficulty in pulling the precious metal from the ground and diminished unmined supply. 

2015 was filled with declarations of supply shortages at mints globally, with both Canadian and US mints experiencing dramatic levels of oversubscription compared to actual inventories of coins.  Weaker production led to substantial delays in deliveries and the surging premiums that were noted above.  If problems continue to arise in the supply chain during 2016, it could add to the upward pressure in silver prices over the medium-term, especially if physical demand remains as robust as it was in 2015.  However, despite the upward pressure, there are risks that are more challenging to quantify, such as weak inflation and the trajectory of monetary policy.  As deflation encircles global economies, it could substantially diminish the appeal of precious metals unless it is met head on with greater central bank accommodation.

Monetary Policy and Inflation

Decisions yesterday from the US Federal Reserve and the Reserve Bank of New Zealand highlight the ongoing challenges for policymakers as they attempt to ward off deflation.  US efforts to raise rates have come at a time of rising volatility and energy prices dragging inflation downward.  New Zealand meanwhile is already jawboning the potential for additional rates cuts as they work to restore weak headline inflation at 0.10% to the target range.  Should the recently hawkish Federal Reserve turn dovish and other global central banks accommodate policy further by printing more fiat currency, the stage could be set for a sustained move higher in precious metals. Furthermore, if confidence in central banking plummets, it could see increased demand for haven assets such as precious metals.

While deflation would typically be viewed as negative for precious metals which are intended as a hedge against inflation, the result will be increased monetary policy accommodation in the form of quantitative easing, asset purchases and interest rate reductions.  On the whole, these are net positives for precious metals that could drive prices substantially higher over the medium-term.  With inflation unlikely to rebound of the near-term amid slowing trade, weak demand for raw commodities, and plunging prices, deflation is already at the doorstep of most advanced economies and something that policymakers will have to address in coming central bank meetings.

Technically Speaking

From a technical point of view, silver prices climbed towards a major technical level this week before retreating back to the downside amid another round of gains in the US dollar.  The precious metal has an inverse correlation with the US dollar, and similar to gold is sensitive to price momentums in the currency as evidenced by the chart above.  Nevertheless, since climbing back from prices last seen in 2009 in the lead up to the bull-run, silver prices have found support in the 50-day moving average.  Despite the fact that the longer-term 200-day moving average remains on the upside trending lower acting as resistance, it does mean that prices have further room to rise in the near-term if they can climb above important resistance at 14.530.  Should risk-aversion and volatility remain a real factor, prices could rise as high as 15.000 over the coming weeks. 

While the stage is set for further gains in silver prices, financial markets do not always behave according to underlying fundamentals.  Pressure will remain heavy on silver prices over the near-term if the US dollar continues to ascend.  However, if central banks are forced to accommodate monetary policy further to deal with rising volatility, deflation, and problematic liquidity conditions, the stage is already set from a physical standpoint for a rally higher in silver prices.  Technically speaking, the outlook is mixed, but that does not mean lack of upside opportunity in the near-term if the 50-day moving average continues to act as support over the medium-term.  With all the factors taken into consideration, silver is at a pivotal point with any new developments likely to have a strong influence on the future of price momentum.

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Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


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