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Silver Prices Maintain Bull Flag Formation Despite Drop in Silver Volatility

Silver Prices Maintain Bull Flag Formation Despite Drop in Silver Volatility

2019-10-18 13:00:00
Christopher Vecchio, CFA, Sr. Currency Strategist
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Silver Price Forecast Overview:

  • Silver prices continue to trade within the bounds of a bull flag, suggesting more gains may not be out of the question; the longer-term bottoming effort remains valid.
  • Silver volatility has dropped precipitously in recent weeks, losing nearly one-third of its value since early-September.
  • Recent changes in sentimentgive us a bullishspot silver trading bias.

Looking for longer-term forecasts on Gold and Silver prices? Check out the DailyFX Trading Guides.

Key macro themes, seemingly on the path to resolution, have developed in manners that have proven harmful to precious metals. Silver prices have suffered in recent weeks as the EU and the UK have moved from animosity to amicability, ironing out the details of a Brexit deal, while progress on the US-China trade war front has reduced concerns over an immediate global recession.

But despite all the progress made, market participants don’t seem ready to signal the ‘all clear’ just yet. Shifts in bonds and FX markets in recent days suggests that, despite the appearance of roaring risk appetite thanks to gains by stock markets, concerns linger about the state of financial markets as 2019 winds to a close. All of the good news – a Brexit deal, a relaxation in tensions between China and the US – may already be priced-in.

US TREASURY 10-YEAR YIELD TECHNICAL ANALYSIS: DAILY CHART (JUNE 2016 TO OCTOBER 2019) (CHART 1)

Silver Prices Maintain Bull Flag Formation Despite Drop in Silver Volatility

After hitting a yearly low and its lowest level since July 2016 on September 3 at 1.464%, the US Treasury 10-year yield rebounded sharply, hitting a high of 1.907% on September 13. Since then, however, the US Treasury 10-year yield has traded in a sideways pattern, appearing to consolidate into a triangle. The US Treasury 10-year yield was last spotted at 1.756%.

WHY DO ‘REAL YIELDS’ MATTER TO SILVER PRICES?

The fall in US Treasury yields around rising growth concerns speaks to 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; and vice-versa.

Silver Prices Not Following 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. The opposite can be said during periods of falling volatility: gold and silver prices tend to suffer.

VXSLV (SILVER VOLATILITY) TECHNICAL ANALYSIS: DAILY PRICE CHART (APRIL 2016 TO OCTOBER2019) (CHART 2)

Silver Prices Maintain Bull Flag Formation Despite Drop in Silver Volatility

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) has dropped precipitously in recent weeks, losing nearly one-third of its value since early-September. VXSLV is currently trading at 23.86, down from a yearly high of 33.30 in September – its highest level since January 3, 2017. Curiously, silver prices aren’t following silver volatility lower.

The 5-day correlation between VXSLV and silver prices is 0.33 and the 20-day correlation is 0.82 (one month ago, on September 4, the 5-day correlation was 0.69 and the 20-day correlation was 0.65). That silver prices continue to maintain their elevation despite a plunge in silver volatility bodes well for prospects.

SILVER PRICE TECHNICAL ANALYSIS: DAILY CHART (SEPTEMBER 2018 TO OCTOBER 2019) (CHART 3)

Silver Prices Maintain Bull Flag Formation Despite Drop in Silver Volatility

Like gold prices, silver prices continue to trade what may be the parameters of a bull flag – the predominant consolidation pattern since the drop from yearly highs were set in September. Despite breaking the uptrend that defined priced action since July, there still remains potential for a turn higher by silver prices, particularly as the downtrend from the September swing highs (bull flag resistance) is currently being tested.

For the time being, silver prices remain are enmeshed in the daily 8-, 13-, and 21-EMA envelope. Daily MACD continues to trend lower, having just broken into bearish territory. Slow Stochastics, however, is attempting to climb back into bullish territory. If a bull flag breakout does occur, a move above the October high at 17.937 would be a necessary first hurdle to clear.

SILVER PRICE TECHNICAL ANALYSIS: WEEKLY CHART (AUGUST 2013 TO OCTOBER 2019) (CHART 4)

Silver Prices Maintain Bull Flag Formation Despite Drop in Silver Volatility

In a mid-September silver price technical forecast update, it was noted that “silver prices may be due for a period of sideways consolidation if the longer-term bottoming effort is to remain valid.” At the time the note was written, silver prices were trading at 18.094; now, they are trading at 17.510. If silver prices continue to hold above the April 2017, September 2017, and June 2018 swing highs, and the 2013 and 2016 swing highs, the longer-term bottoming effort remains valid. Opportunities to ‘buy the dip’ are still eyed.

IG Client Sentiment Index: Spot Silver Price Forecast (OCTOBER 18, 2019) (Chart 5)

Silver Prices Maintain Bull Flag Formation Despite Drop in Silver Volatility

Spot silver: Retail trader data shows 86.4% of traders are net-long with the ratio of traders long to short at 6.33 to 1. The number of traders net-long is 2.0% lower than yesterday and 2.0% lower from last week, while the number of traders net-short is 3.0% higher than yesterday and 5.5% higher 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. Yet traders are less net-long than yesterday and compared with last week. Recent changes in sentiment warn that the current spot silver price trend may soon reverse higher despite the fact traders remain net-long.

FX TRADING RESOURCES

Whether you are a new or experienced trader, DailyFX has multiple resources available to help you: an indicator for monitoring trader sentiment; quarterly trading forecasts; analytical and educational webinars held daily; trading guides to help you improve trading performance, and even one for those who are new to FX trading.

--- Written by Christopher Vecchio, CFA, Senior Currency Strategist

To contact Christopher Vecchio, e-mail at cvecchio@dailyfx.com

Follow him on Twitter at @CVecchioFX

View our long-term forecasts with the DailyFX Trading Guides

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