silver is becoming a value magnet

Despite geopolitical tensions in North Korea, Iraqi Kurdistan and Catalonia, the global financial markets embraced risk in October, led by a Dow Jones index that soared above 23,300 points and the S&P 500 index at 2,572 points, thanks to strong corporate earnings, a surge in financials and industrials on the prospect of Trump's tax reforms. While investors are sceptical about inflated valuations in the eight-year bull market, there is no fundamental rationale for a bear market in risk assets.

The world is experiencing its first synchronised global growth recovery since 2009. Inflation is still low and central bank policy is still accommodative. A tsunami of global liquidity has led to fund inflows in Europe, Asia and emerging markets. Despite the recent spike in US Treasury bond yields, government bonds are unattractive relative to equities. Volatility has sunk across asset classes and the Chicago Volatility Index now regularly trades below 10. Is this the Panglossian best of all possible worlds in risk assets?

I expect the yield on the 10-year US Treasury bond note to range trade between 2.10 per cent and 2.50 per cent for the next two months even as the Federal Reserve raises the overnight borrowing rate by 25 basis points at the December FOMC. Yet as wage inflation in the US rise, pressures for higher interest rates will accelerate. If President Trump appoints Kevin Warsh or Dr John Taylor as the next Fed chairman expect monetary policy tightening to be less gradual than under the Janet Yellen regime.

US equites can well underperform relative to Hong Kong/China, Europe and Asian emerging markets in the next three months. As the central bank in Washington unwinds its $4.5 trillion balance sheet, I expect the sweet spot in global equities to shift to dividend growth themes in Europe, Japan and Asia. The biggest risk to global equities are a failure of Trump's tax reform or an inflation or growth scare on Wall Street. The fall in the US Dollar Index from 102 in early 2017 to 93.5 now and the relative performance of US cyclicals reflects investor skepticism about the post Trump "asset allocation" theme.

Now that the Iraqi Army has captures the oilfields of Kirkuk after the KRG's independence referendum and the Saudi Arabians have reaffirmed their output cut deal with Russia, I expect the money-making wave in energy stocks and commodities to continue. Robust global growth and a correction in the King Dollar trend means aluminium, copper and nickel supply-demand imbalance will power mining shares in New York and London. I am bullish on silver as an investment theme in 2018.

The white metal is one of the few undervalued assets in global markets now that Japan's Nikkei Dow index has surged 1,600 points since I flagged Marunouchi as another undervalued theme in this column. Japan is no longer dirt-cheap but is not as expensive as US or European equities. Silver is correlated to both synchronised global economic growth and new technology-driven applications in smartphones, digital cameras, solar power electric cars and space exploration. The gold-silver ratio is well below historic averages. A gold-silver ratio of 75 tells me that value, like beauty, lies in the eye of the beholder in the white metal. After all, the 100-year average for the gold-silver ratio is 40, which suggests silver can theoretically double to $32 an ounce. The ghost of Nelson Bunker Hunt tells me that as inflation accelerates, silver prices can well begin to outperform gold, as happened in 2016. The only reason gold has outperformed silver in 2017 is the eight per cent fall in the US dollar index makes the inverse correlations trade with Auric irresistible.

Silver has seen the first decline in annual production since 2002, which will only exacerbate the supply deficit even as global smartphone sales surge. Commercial trades are beginning to accumulate silver in the futures markets. This has historically been a bullish accumulation zone for silver. In any case, mine supplies from Latin America could get tighter now that Tahoe has suspended its Escobar mine in Guatemala, one of the world's largest. Fed rates will be gradual and well telegraphed, so I doubt if aggressive monetary tightening precludes a bull market in silver in 2018. I expect spot silver to rise to $20 an ounce sometime in the next 12 months.

Source: Khaleej Times