Silver Prices Fall Back to Key Trend Support - Next Levels for XAG/USD
Silver Prices Overview
- With the US-China trade war back in détente, US Treasury yields have jumped sharply, reducing the safe haven appeal of precious metals. US Treasury yields have increased by their fastest rate since January 2019.
- If a short-term pullback takes shape, traders may want to consider the opportunity to engage the longer-term bullish bottoming effort in silver prices.
- Recent changes in sentimentgive us a mixed spot silver trading bias.
The recovery in risk appetite continues. With China making more entreaties to de-escalate the trade war with the United States, recent days have seen investors shed lower yielding and safe haven assets, like US Treasuries and the Japanese Yen, while bidding up higher yielding and high beta assets, like US equities and the Australian Dollar. Some of the biggest movers in financial markets, however, remain precious metals like gold and silver.
US TREASURY YIELDS TAKE SHINE OFF GOLD AND SILVER
Now that the US-China trade war has settled into a short-term truce, investors are no longer expecting the G10 currencies’ central banks to deliver aggressive easing measures in the immediate future. The second order effect has been the sharpest rise in short- (1m to 2y) and medium-term (3y to 7y) US Treasury yields since January 2019 over the past week. Rising yields tend to be bad for precious metals.
WHY DO ‘REAL YIELDS’ MATTER TO SILVER PRICES?
The rise in US Treasury yields around the latest US-China trade war developments undermines one of the most important fundamental underpinnings of precious metals’ rallies: environments that produce falling real yields tend to be the most bullish. On the other hand, environments that produce rising real yields tend to be the most bearish for precious metals.
Real yields are inflation-adjusted yields: in this case, the US Treasury 10-year yield minus the headline inflation rate. Why does this matter? Investing is all about asset allocation and risk-adjusted returns. On the asset allocation side, it’s about achieving required returns given the investor’s wants and needs.
If inflation expectations are rapidly increasing, you would expect to see fixed income underperform: the returns are fixed, after all. Why would you want to have a fixed return when prices are increasing? On a real basis, your returns would be lower than otherwise intended.
Rising US real yields means that the spread between Treasury yields and inflation rates isincreasing. If precious metals yield nothing (no dividends, coupons, or cash flows), they would be ill-suited to hold when US real yields rose.
Silver Prices Follow Silver Volatility Lower
While other asset classes don’t like increased volatility (signaling greater uncertainty around cash flows, dividends, coupon payments, etc.), precious metals tend to benefit from periods of higher volatility as uncertainty increases gold’s and silver’s safe haven appeal.
VXSLV (SILVER VOLATILITY) TECHNICAL ANALYSIS: DAILY PRICE CHART (APRIL 2016 TO SEPTEMBER 2019) (CHART 1)
Silver volatility (as measured by the Cboe’s gold volatility ETF, VXSLV, which tracks the 1-month implied volatility of gold as derived from the SLV option chain) is running higher around the latest US-China trade war developments. VXSLV is currently trading at 29.13, down from 34.56 last week, its highest level since January 3, 2017.
The 5-day correlation between VXSLV and silver prices is 0.46; and the 20-day correlation is 0.87 (one month ago, on August 12, the 5-day correlation was 0.91 and the 20-day correlation was 0.64). It still holds that silver prices will remain weak so long as silver volatility continues to trend lower, although given the weakening of the 5-day correlation, it also holds that silver prices may not fall as far as a drop in silver volatility may otherwise imply.
SILVER PRICE TECHNICAL ANALYSIS: WEEKLY CHART (AUGUST 2013 TO SEPTEMBER 2019) (CHART 2)
As noted in our most recent silver price technical forecast update, “traders should be cautioned that the weekly shooting star/inverse hammer warns of potential for a bearish reversal in the near-term.” While the move by silver prices above the (1) April 2017, September 2017, and June 2018 swing highs, and the (2) 2013 and 2016 swing highs has been maintained in recent days, there remains scope for pullback. Trading is a function of both price and time; given the scale of the recent rally, silver prices may be due for a period of sideways consolidation if the longer-term bottoming effort is to remain valid.
SILVER PRICE TECHNICAL ANALYSIS: DAILY CHART (SEPTEMBER 2018 TO SEPTEMBER 2019) (CHART 3)
Per the most recent silver price technical forecast update, it was noted that “A break above near-term doji resistance at 17.489 would signal a bullish continuation effort for silver prices. The measured move now calls for silver prices to trade into 18.468. Having achieved this breakout target, silver prices may be due for a period of profit taking – traders digesting the recent move, if you will…the bearish outside engulfing bar on the daily chart further reinforces the idea of a potential for a short-term pullback.”
Silver prices have dropped fairly quickly, returning to the daily 21-EMA for the first time since July 31. Daily MACD continues to trend lower, albeit in bearish territory, while Slow Stochastics has slumped below its neutral line. Silver prices have not closed below the daily 21-EMA since July 11. If the silver price rally since the end of May is going to be maintain, the daily 21-EMA will hold up as key support.
IG Client Sentiment Index: Spot Silver Price Forecast (SEPTEMBER 11, 2019) (Chart 4)
Spot silver: Retail trader data shows 82.3% of traders are net-long with the ratio of traders long to short at 4.65 to 1. The number of traders net-long is 0.3% higher than yesterday and 8.4% higher from last week, while the number of traders net-short is 3.9% higher than yesterday and 29.1% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests spot silver prices may continue to fall. Positioning is less net-long than yesterday but more net-long from last week. The combination of current sentiment and recent changes gives us a further mixed spot silver trading bias.
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--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
To contact Christopher Vecchio, e-mail at firstname.lastname@example.org
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