Silver prices surge above $27.50 as traders bet on higher inflation ahead

• US 10-year breakeven inflation expectations hit more than 2-year highs, boosting precious metal markets.
• Spot silver prices crossed above the $27.50 mark for the first time since September.

Spot silver prices (XAG/USD) have put in a solid performance thus far on the first trading day of 2021, with silver spot market price crossing above the $27.50 level for the first time since September and breaching December 2020’s previous high at $27.41. On the day, silver prices are up by more than 4.0%, with prices having opened Asia Pacific trade beneath the $26.50 level. Other precious metals are also performing exceptionally well; spot gold (XAU/USD) is up roughly 2.5%, spot platinum (XPT/USD) is over 5% and spot palladium (XPD/USD) is up over 0.5%.

Precious metals market buoyed by inflation bets

Markets are in an upbeat mood on the first trading day of the year; stocks are up in the US and Europe, WTI was up before some OPEC+ concerns chopped the complex down from highs, industrial commodities are up and US bond yields are higher and the yield curve steeper. No specific news or headline is driving the upbeat feel to trade. Rather, markets are seemingly “picking up where they left off” at the end of last year in terms of betting on a combination of 1) a strong global economic recovery in 2021 as vaccines end the Covid-19 pandemic and 2) continued support from global monetary policymakers.

The upbeat mood has put the US dollar on the defensive (the Dollar Index has slipped back to close to 2020 lows and trades in the 89.50s) and seen a pick-up in inflation expectations; US 10-year breakeven inflation expectations rose above 2.0% for the first time since 2018 on Monday. Despite risk on flows driving upside in nominal US yields, the rise in inflation expectations is keeping US real yields close to recent lows; the US 10-year TIPS yield is just below -1.07%, just above December’s -1.089% low. A move back towards last year’s lows around -1.1% seems likely. The combination of the weaker US dollar (to which precious metals are negatively correlation), rising inflation expectations (precious metals are seen as a hedge against inflation) and real yields staying close to lows (keeping incentive to hold non-yielding precious metals over negative-yielding debt high) is helping support precious metals prices.

Key themes this week

Silver traders (and precious metal traders more broadly) will need to keep an eye on two main factors this week; 1) US data and 2) the US Senate elections in Georgia.

On the former, ISM manufacturing (released on Tuesday) and services (released on Thursday) will provide a timely update as to the state of the US economy in December (at least, as far as sentiment in the economy is concerned), amid the continued rise in Covid-19 prevalence in the community. Official labour market numbers for December (released on Friday) will also be key. Expect markets to be able to look through any short-term weakness given the promise of 1) vaccines turning the situation around soon and 2) that the Fed will be there to step in and offer further monetary support if needed. On which note, bad data might well be precious metal positive if it results in pricing in of further monetary stimulus.

On the latter; two seats that will decide whether the Republicans hold onto, or Democrats win, a majority in the Senate are up for grabs on Tuesday. Markets seem to expect the Republicans to be able to hold onto at least one seat, meaning they maintain their majority in the Senate, but polling and betting odds makers seem to suggest things are pretty close. If the Democrats can win, this would be the more surprising outcome and thus provoke the larger reaction given that a Democrat-controlled Congress means trillions more in government spending in 2021. The likely market reaction to this would be higher nominal US nominal bond yields (in anticipation of higher debt issuance) and higher inflation expectations (given more stimulus).

How this would impact USD and precious metals depends on how much of this new debt markets expect the Fed to monetise; if markets expect them to monetise enough to keep US real yields close to recent lows, then this is likely to be negative USD and positive for precious metals. If they allow nominal and real interest rates to rise, this is likely to be a negative to precious metals (and risk assets more broadly). Given the Fed’s pledge to keep monetary conditions accommodative for the foreseeable future until the bank is much closer to its mandated goals (on inflation and unemployment), it seems unlikely that they will allow a significant rise in real yields (as well as the fact that the US would barely be able to afford it!). Hence, markets are likely to expect that more fiscal stimulus is going to come hand in hand with more monetary stimulus.