Silver prices are looking into the abyss below weelky support

• Silver is on the back foot and looking into the abyss.
• The US dollar smile theory is a dominant theme as covid risks deepen.

At the time of writing, silver is down another 1.09% on the day, albeit after recovering from the lows of the day so far.

XAG/USD has travelled between a high of $25.27 and a low of $24.81 pressured once again by a resilient US dollar despite the better risk tone on Tuesday. 

The US dollar climbed to a three-month peak on Tuesday in a flight-to-safety bid, as investors remained anxious about a fast-spreading coronavirus variant that could throttle global growth.

However, the US stock market has bounced back to life, snapping a multi-day losing streak. The benchmarks have been helped along due to a string of upbeat earnings and some revived economic optimism.

Investors have begun to rationalise that fears of another crippling round of global lockdowns are potentially overblown.

All three major US stock indexes were up more than 1% with the blue-chip Dow, on the heels of its worst day in nine months, leading the charge. The session, so far, has put the S&P on track for its first advance in four days and the Nasdaq's first gain in six.

This backdrop is bullish for silver as it likely reflects a temporary glitch in the investor optimism which could equate to a full-blown risk rally that would be expected to curb the US dollar's advance. 

S&P 500 / DXY daily divergence

S&P 500 / XAG/USD daily correlation 

Meanwhile, however, there is the case being made for a longer-term bullish US dollar based on the dollar smile theory and prospects of worst to come from the Delta variant, now the dominant coronavirus strain worldwide.

The United States, for instance, has seen a surge in infections, especially in areas where vaccinations have lagged.

However, the immediate concern for markets is whether we are going to see a slowdown in the global economic recovery.

Early Asia 21/07 Update:

• Risk-off: bioRxiv study shows J&J vaccine may be less effective against Delta covid variant

This could be the overriding force that results in strong demand for the greenback, especially as all current data points to a hawkish theme at the Fed. 

''Since the FOMC last met, the labour market, Retail Sales and inflation have all come in very strong. While the rise in COVID cases is a valid concern, there is a risk that the market is becoming too dovish on its expectations for the Fed’s communication next week,'' analysts at ANZ Bank said. 

This completes the thesis that the US dollar smile theory is real and a headwind for precious metals for the foreseeable future.

Analysts at Brown Brothers Harriman described the theory as ''strong US data are feeding into increased dollar bullishness as the Fed continues to take tentative steps towards tapering...On the other hand, growing risk-off impulses are helping the dollar recently. This supports the view that the greenback is likely to benefit in either situation. Hence, the smile as the dollar turns up at both ends of the risk spectrum.''

The gains in the dollar come at a time when yield differentials have moved against it. Benchmark 10-year US Treasury yields dipped to a five-month low below 1.20% on Monday.  

The yield in recovery, it could eventually propel the greenback even higher, especially as investors move away from emerging markets and into US dollar-denominated holdings instead. 

Meanwhile, the precious metals barometer for risk-off flows, gold, has been unable to rally, despite the ongoing risk-off.

Bearish for silver as well, as it tends to track price action in its sister metal over time, analysts at TD Securities argue that this ''highlights that speculative flows remain particularly weak, reinforcing the potential for a deeper pullback,'' in gold prices. 

Gold /silver weekly correlation 

Over the past number of weeks, the gold to silver ratio has spiked as the divergence in the chart above lessens over time. 

Silvers bullish trend could well have met its apex and be set for a significant downturn in the coming weeks ahead. 

Silver weekly chart