By Samson Li
8th February 2018
A hawkish statement from Fed Chairman Yellen in January, including a mention of the potential for accelerated inflation, has the market pondering whether the Fed may speed up the pace of interest rate hikes. Global funds have been selling off bonds fearing rate hikes, and the U.S.10-Year Government bond yield has risen to 2.71%, which sparked another round of equities selling. Elements in the market feared that central banks tightening could possibly kill off the current momentum of the global economy, especially considering that the U.S. equity indices have already brought lucrative returns in the past 10 years and some people may feel it is about time to a more material retreat. Bond guru Bill Gross also stated that the bond market has already been in a bear market, after a double-bottom at 1.45%. It remains to be seen if the global debt market (which is much larger than the global equities market) is now in a bear phase, and how that will affect the equities market.
As a result, U.S. equities (and the global stock markets as well) has been sold off on fears, with both the S&P index and the Nasdaq losing approximately 6% between end of January and the close on 5th February. The Fear Index (VIX) has surged from 15 to 37.32 in just five days. Nevertheless, the S&P has only recorded a loss of 0.9% while Nasdaq still managed to record a gain of 0.9% year-to-date.
While the market was fully expecting another rate hike in March, the weakness of the equities market in recent days could make things complicated. Based on the CME FedWatch Tool, the probability that the market has assigned that the Fed will raise the interest rate at the March meeting fell from 77.5% on the 5th February to 69.0% after the Dow Jones Index plunged 1,175.21 points in one day (a 4.6% plunge after already falling 2.54% the previous day). Therefore if the equities market failed to stabilize, it is very unlikely that the new Fed, under the leadership of Jerome Powell, would make any dramatic moves during the March meeting. A postpone of a rate hike in March should aid the pricings of commodities, even if the effect might only be short lived.
The gold: silver ratio ranged between 76 and 79 on an intraday basis in January, closing the month at 78.0 basis the LBMA gold a.m. and silver prices for 31st January. After the correction in the equities market in early February, the gold to silver ratio has now been flirting close to 80, a level often seen when a crisis breaks out and investors turn to safe haven assets by bidding up the gold price compared to silver. Indeed, in our recent article ‘Silver lagged in 2017, may outperform in 2018, but beware of market volatility’, we have already expressed our concerns that with both the gold:silver and gold: platinum ratios hovering at historical high levels, it could be a signal that some smart money might have already been placing bets on geopolitical risk and the potential downside in equities.
In the longer run, we believe silver should continue to present an attractive long term, if bumpy, potential. The recovery of the global semiconductor sector starting in 2017 should continue meaning that industrial demand for silver will remain on the uptrend. Furthermore, as the weekly CFTC report suggested, current market sentiment for silver is lukewarm at best, with the net long managed equivalent equal to 4,093 tonnes of silver (at the end of January), compared to the annual average of 7,546 tonnes equivalent in 2017. This suggests that silver is not in any bubble, and further sustainable downside should be relatively limited compared to equities. Once the current retracement seen in the global equities market as well as market sentiment stabilises (but remains to be seen how long this correction could last), we think the gold to silver ratio will begin to fall, suggesting that silver will once again offer itself as a gearing to an investment in gold.
