Where is slv headed?
After adding to my long positions in the iShares Silver Trust (NYSEARCA:SLV) in the second half of last year (see 'SLV: Signs Of Capitulation' and 'SLV: The Long-Term Bull Market Has Likely Resumed'), I have used the latest rally to take some profit as silver bumps up against key downtrend resistance. The risk-reward outlook has deteriorated for now, with the commodity complex under downside pressure and US real bond yields remaining near cycle highs. However, I remain bullish from a long-term perspective as the metal remains undervalued and I expect current tight monetary conditions to reverse over the coming years.
The SLV ETF has tracked the spot price with a median 12-month tracking error of just 0.48%, and should continue to offer investors direct exposure to the metal. With an expense fee of 0.50%, this is far lower than the spreads on buying the physical metal. SLV is the largest and most liquid silver ETF, but has a slightly higher expense ratio relative to others such as the Aberdeen Standard Physical Silver Shares ETF (SIVR). Despite the rally in SLV assets under management continue to move gradually lower, remaining 30% below their February 2021.
The SLV appears to be struggling to overcome key down trendline resistance from the February 2021 high, which marked the peak of the reddit-inspired squeeze. A close above USD22.5 is needed to suggest a resumption of the bull market and set up a run at the USD25 area.
Silver prices tend to be driven by monetary demand and industrial demand in roughly equal measure. We can gauge monetary demand by looking at the price of gold and real bond yields. Gold's rally appears to be giving a green flag for further silver upside. While silver is struggling to break resistance, gold has continued to rally.
However, as I have noted in recent gold articles ('Gold's Rally Is Overdone, Here's How To Play It'), this rally is not supported by real bond yields, which remain near cycle highs. To be clear, by real bond yields I am talking specifically about long-term US inflation-linked bond yields rather than the real yield calculated using trailing CPI. The 10-year US inflation-linked bond yield currently sits at 1.3%, which reflects the 10-year yield of 3.5% and 10-year inflation expectations of 2.2%. As the chart below shows, 10-year inflation-linked bond yields have been extremely well correlated with gold in recent years. Unless we see real bond yields head sharply lower, gold remains susceptible to a downside reversal, which would be expected to also undermine the silver price.
Industrial demand for silver can be gauged by looking at the broader commodity complex. Over the long term there has been a strong positive correlation between silver and the Bloomberg commodity index, but recent silver strength has come even as the commodity complex has fallen. Previous periods of sharp silver gains alongside commodity weakness have given way to downside reversals in silver as the chart below shows. While there is still potential for silver prices to continue rising, the commodity complex would have to begin to recover to suggest such gains are sustainable.
While silver faces short-term risks from rising real yields and weaker commodity prices, the metal remains undervalued from a long-term perspective. The chart below shows the price of silver relative to its fair value based on its long-term correlation with a 50:50 basket of gold and the commodity complex. I have used this chart in several articles over recent years to show how silver is deeply undervalued, and while this degree of undervaluation has narrowed significantly in recent months, the metal still looks cheap.
Additionally, while real bond yields pose a headwind to monetary demand for precious metals right now, I fully expect to see monetary conditions ease up significantly over the coming months and years as falling headline CPI allows the Fed to focus on maintaining financial stability and preventing a potential debt crisis that could result from high government borrowing.
