Silver drops back below $26.00 as USD nurses its wounds

• XAG/USD is trading just to the south of the $26.00 level having dipped below it amid a mild correction higher in USD.
• But the fundamental picture remains supportive for the precious metal, with real yields still dropping and inflation expectations elevated.

Spot silver (XAG/USD) prices have dropped back below the $26.00 level on the final trading day of the week, having been as high as $26.10 on Thursday. Though silver prices are off daily lows in the $25.60s, the precious metal still trades with losses of around 0.6% or 15 cents.

USD licks its wounds

The main reason why precious metals, in particular silver, have been on the back foot on Friday is given USD’s mild recovery. Indeed, the Dollar Index (DXY) has recovered back towards the 90.00 level from yesterday’s lows in the 89.70s. Nothing in particular has changed for the US dollar fundamentally speaking (markets still expect a dovish Fed and fiscal stimulus in the new year), so Friday’s move is most likely a result of shorts taking profit/position adjustment on the final day of the week, which, incidentally is the final trading day of the calendar year for many (lucky) market participants who will be taking the rest of the year off to enjoy Christmas with their families.

Precious metal picture remains bullish

Despite Friday’s minor losses in silver (and other precious metals such as palladium and platinum), the picture for the precious metal remains supportive. US 10-year TIPS yields (the real yield on the US 10-year bond) have been moving back towards yesterday’s -1.06% lows (currently trading around -1.04%) and inflation expectations remain close to recent highs above 1.9%.

For reference, two key drivers of precious metal demand are 1) real yields on US bonds (the lower, the more attractive it is to hold non-yielding precious metals) and 2) inflation expectations, given that precious metals are seen as the ultimate hedge against future inflation (in other words, given their scarcity, precious metals will always hold their value).

So as long as the economy continues to improve and inflation expectations continue to rise (as is likely to be the case with fiscal stimulus on the way and possibly more inflationary Fed action) and as long as US real yields remain deeply in negative territory (as the Fed wants them to for the foreseeable future to assist the economic recovery), precious metals are likely to remain supported.

Silver testing key support area

XAG/USD is testing the top of a range that has been in flat since late-September. The $26.00 region has proven to be formidable support back in late-August and early September and then resistance in early November, and the precious metal is struggling to break back above this area now. Should this attempt fail, a gradual move back towards support around $25.00 is likely. If it does break above, a gradual move towards the mid-September highs above the $27.00 level at $27.60ish will be likely.

XAG/USD daily chart