Silver Prices Clear Downtrend from September High - What's Next for XAG/USD?
Silver Price Forecast Overview:
- Silver prices have edged their way out of a potential bull flag formation, increasing the potential for more gains; however, the move lacks enthusiasm.
- Silver volatility continues to edge lower, although silver prices have not followed to the downside.
- Recent changes in sentimentgives us a stronger spot silver-bearish contrarian trading bias..
After an exceptional run between the end of May and the start of September, silver prices have taken a breather during October. With the US-China trade war on the path towards de-escalation and a Brexit deal coming into focus, market participants have reduced their holdings of safe haven assets lapped up during prior periods of risk aversion. As investors have increased their holdings of equities, they’ve pared back their holdings of sovereign debt. A rebound in sovereign bond yields, particularly in US Treasuries, has reduced the relative appeal of precious metals in recent weeks.
US TREASURY 10-YEAR YIELD TECHNICAL ANALYSIS: DAILY CHART (JUNE 2016 TO OCTOBER 2019) (CHART 1)
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 1.754% - essentially unchanged from our last silver price technical forecast update, when it yielded 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 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 23.81, 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 0.28 and the 20-day correlation is 0.10 (one month ago, on September 25, the 5-day correlation was 0.95 and the 20-day correlation was 0.66). The current 20-day correlation is at its lowest point since May 22, 2019. It thus still holds that, as noted in our last updated, “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)
Even as silver volatility has dropped to multi-week lows, silver prices have been able to trade sideways for most of October. Given that trading is a function of price and time, silver prices may have just breached what could be considered resistance in the descending channel/bull flag pattern in place relative to the yearly highs set in September. But it’s not exactly a convincing break, given the lack of enthusiasm to the topside.
At this point in time, the near-term outlook for silver prices has started to become cautiously bullish. Silver prices are still intertwined in the daily 8-, 13-, and 21-EMA envelope. Daily MACD has flattened out just below the signal line, suggesting bearish momentum has failed to gather traction. Slow Stochastics, however, is in bullish territory (albeit trending lower). If a bull flag breakout is indeed gathering pace, it still holds that a move above the October high at 17.937 is necessary confirmation.
SILVER PRICE TECHNICAL ANALYSIS: WEEKLY CHART (AUGUST 2013 TO OCTOBER 2019) (CHART 4)
In our most recent silver price technical forecast update, it was noted that the longer-term bullish perspective had not changed despite near-term weakness: building on the 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 September note was written, silver prices were trading at 18.094; now, they are trading at 17.548.
Accordingly, if silver prices maintain their gains above the April and September 2017 highs, 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 now that silver prices have returned to their weekly 8-, 13-, and 21-EMA envelope.
IG Client Sentiment Index: Spot Silver Price Forecast (OCTOBER 23, 2019) (Chart 5)
Spot silver: Retail trader data shows 88.4% of traders are net-long with the ratio of traders long to short at 7.65 to 1. The number of traders net-long is 2.0% higher than yesterday and 2.6% higher from last week, while the number of traders net-short is 14.0% lower than yesterday and 25.0% 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. Traders are further net-long than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger spot silver-bearish contrarian trading bias.
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--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
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