Silver And Oil- A Tale Of Two Directions

  • Silver takes off
  • Crude oil falls to the lowest level since late June
  • The Fed remains dovish
  • Silver could become explosive
  • Crude oil is likely to find support

In the world of commodities, most market participants pay most attention to the crude oil and precious metals markets. This past week, gold and silver headed higher while the energy commodity went the other way.

In many ways, the reason for the metal’s ascent is a function of the weakness in the oil market. The US Federal Reserve told markets at its June meeting that “crosscurrents” and “uncertainty” in the global economy is a reason why rate cuts are on the horizon. Lower interest rates could weigh on the value of the US dollar, which tends to be bullish for gold and silver. Falling rates also lower the cost of holding precious metals. However, the ongoing trade dispute between the US and China is causing a slowdown in the global economy. As the economy slows, demand for energy declines, sending the price of crude oil lower. Meanwhile, the supply side of the fundamental equation for petroleum is likely to continue to provide support for the energy commodity. 20% of the world’s supplies travel through the Strait of Hormuz each day, which is the flashpoint for the rising tensions between the US and Iran.

Silver takes off

Gold moved above its critical technical resistance level at the July 2016 high at $1377.50 in June. When gold hit its peak three years ago, the price of silver rose to a high at $21.095. Meanwhile, in June, silver could only make it to a high at $15.555 as the precious metal did not even rise to a new peak for this year. Over the past week, silver finally made a new high for 2019.

Source: CQG

As the weekly chart highlights, the price of silver rose to a high at $16.505 on the continuous contract, and the September futures contract reached a peak at $16,625 per ounce on Friday, July 19. Profit-taking took the price back down to the $16.20 level as September silver settled the week at $16.1965. Silver had been making lower highs since July 2016, but last week it broke that pattern as the price rose above the 2019 high and to the highest price since June 2018.

The silver-gold ratio fell from over 93:1 to the 88:1 level as gold’s little brother played catchup with the yellow metal. Time will tell if the technical break to the upside is just the start of a more significant rally in the silver market. Gold rose to a new high at $1454.40 on the active month August futures contract on Friday, July 19. At the settlement prices on July 19, silver gained 6.29% on the week while the price of gold moved just over 1% higher.

Crude oil falls to the lowest level since late June

While gold and silver posted gains last week, the price of crude oil moved lower.

Source: CQG

As the daily chart of August NYMEX crude oil futures illustrates, the price dropped from $60.39 on Friday, July 12 to close at $55.63 on July 19, a decline of 7.9% on a week-on-week basis. Oil began to fall early in the week on the news that Chinese GDP rose by 6.2%, the lowest level on record. China’s economic data weighed on the price of the energy commodity. Meanwhile, Secretary of State Mike Pompeo’s comments at a cabinet meeting that Iran could be ready for direct negotiations with the US increased the pace of selling in the oil market. August crude oil futures on NYMEX fell to a low at $54.72 on July 18, which was the lowest price since June 20.

The Fed remains dovish

At the end of last week, it was not a question of if the Fed will cut the Fed Funds rate at its July 31 meeting, but how much the rate will fall. After comments from Chairman Powell before Congress and a speech by NY Fed President John Williams, the market geared up for a 50-basis point cut on July 31. However, right before the blackout period where the voting members of the central bank make no comments, Fed Governor Eric Rosengren sat down for an interview with CNBC Friday afternoon after the market closed. Rosengren highlights the overall strength of the US economy. He said that recent employment and inflation data indicate a continuation of economic growth. Rosengren expects that GDP with come in around the 2% level for the second quarter of this year and did not appear convinced that a rate cut is necessary. He highlighted “uncertainty” and “crosscurrents” that center around Europe and China. When it comes to Europe, a hard Brexit poses a threat to the global economy, and the ECB continues to take an accommodative posture. At the same time, the ongoing trade dispute between the US and China has weighed on the Chinese economy, and recent GDP data at 6.2% growth was at a record low for the world’s second-leading economy. At the same time, Rosengren said that he pays no attention to pressure from the President when it comes to monetary policy as the Fed reports to Congress.

The overall tone of Rosengren’s comments was a lot more hawkish than Chairman Powell and the NY Fed President’s latest messages to markets.

Alan Greenspan once said that the optimal position for the central bank of for the market to go into each FOMC meeting unsure if it will raise or lower rates. Rosengren’s interview is a reason that we should expect no more than a 25-basis point rate cut on July 31. In any case, lower US rates are bullish for commodities prices, but the reason for a rate cut makes a case for caution when it comes to commodities prices. China is the demand side of the equation in the raw materials market, and economic weakness will likely continue to weigh on requirements and will keep prices under control in the aftermath of a one-quarter of one-percent rate cut by the US central bank.

Silver could become explosive

Silver has all the elements of a market that is ready to make a significant move on the upside. Gold is trading at its highest price in one-half of a decade. Interest rates are falling, which will likely slow down the ascent of the US dollar. The price traded above the 2019 high and ended the pattern of lower highs on the weekly chart that had been in place since 2016.

Source: CQG

The monthly chart shows that both price momentum and relative strength are rising in neutral territory. The metrics are at a level where there is more room on the upside. Open interest, the total number of open long and short positions in the silver futures market is rising with the price of the precious metal. In a futures market, increasing open interest and ascending price is typically a technical validation of an emerging bullish trend. Monthly historical volatility at around the 16% level is steady, which can be a sign that the rally has room to continue.

Above last week’s high at $16.505, the next level of technical resistance stands at the 2017 peak at $17.705 and the 2018 high at $18.655. If silver rises above these levels, the 2016 peak at $21.095 will be the upside target. The silver-gold ratio dropped from its recent high at over 93:1 to the 88:1 level at the end of last week. The modern-day average for the ratio dating back to the 1970s stands at 55:1. In 2011, when gold and silver hit highs, the ratio fell to under 33:1. Silver is a highly volatile market. When it starts to move, it is possible that a herd of buyers will flood into the market if the sentiment shifts to expect a significant percentage price move in the metal. With gold at the $1426.70 level on July 19, a return to the historical average would put the silver price at $25.94 per ounce, $9.745 above the closing price last Friday. Silver has the potential to make an explosive move to the upside, and risk-reward favors a long position with a tight stop in the silver market. Risking $1 on the downside for the potential of an almost $10 gain is a favorable risk-reward ratio.

Crude oil is likely to find support

US oil production and global economic weakness are reasons for concern when it comes to the price of crude oil. However, with 20% of the world’s oil supplies traveling through the Strait of Hormuz each day, Iran stands as a danger for the logistical route. Over recent months, Iran attacked oil tankers in the region. The Iranians shot down a US drone and fired missiles into Saudi sovereign territory. Most recently, the US shot down an Iranian drone, and Iran hijacked two tankers; one with a British and another with a Liberian flag. While the current path of least resistance of the price of crude oil is lower, a continuation of selling could depend on the start of talks between the US and Iran. Last week, US Secretary of State Mike Pompeo told markets that Iran wants a deal with the US. However, that could be a pipe dream considering the latest incidents. Moreover, Iran and the US have had long-standing problems since the late 1970s at the time of the Islamic Revolution. The hostage crisis in 1979, a bombing that killed US military personnel in Lebanon, Iran’s threats to Israel, and funding for terrorist organizations throughout the Middle East are reasons why negotiations are not likely any time soon.

Iran is likely to continue to provoke the US up to a point as neither side wants a war. Iran could be waiting for the 2020 Presidential election in the US to see if they must deal with President Trump or if a new leader would take the US back into the 2015 nuclear nonproliferation agreement. Therefore, with the threats to production, refining, and logistical routes in the Middle East rising, the price of crude oil is likely to find support on price weakness. I do not expect to see a $40 handle on crude oil during the current corrective move.

Oil went lower and silver higher over the past week. I believe we are in for lots of volatility in both markets over the rest of 2019.