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(Kitco News) - Silver is doing what it does best, outperforming gold in a new upswing after the U.S. government reported weaker-than-expected inflation pressures.
However, Bart Melek, head of commodity strategy at TD Securities, warned that the silver market needs to see a significant change in investor demand and renewed industrial interest if it is going to escape the gravity around $23 an ounce in the near term.
"Concerns surrounding higher-for-longer interest rates, a lack of speculative appetite, less physical demand amid Chinese economic weakness and a pending U.S. recession suggest the silver market is set to be looser than the projected 110koz annual deficit this year suggests," he said. "Consequently, silver is projected to trend near a low $23/oz for much of the next three months."
However, Melek added that he sees solid potential for silver by year-end as the Federal Reserve starts to cut rates as recession conditions begin to bite.
"As it becomes clear that the Fed and other central banks will start to pivot to a more dovish monetary policy stance in the early months of 2024, boosting the prospects for an economic recovery on the horizon, we expect the white metal will set its sights towards $26/oz in the final days 2023," he said.
Although Wednesday's cool inflation data is providing solid support for silver, it has not impacted interest rate expectations. Markets have all but priced in a 25-basis point hike in two weeks. However, growing optimism that this will be the last rate hike is a major catalyst behind Wednesday's rally.
September silver futures last traded at $24.010 an ounce, up 4% on the day.
Despite its recent lackluster performance, silver has been attracting a lot of attention as many investors are expecting industrial demand, driven by the global green energy transition, to push prices higher.
Analysts were forecasting that industrial demand would push the silver market into a deeper deficit this year. But Melek said that he was skeptical the market will see deep deficits this year. He pointed out that the Federal Reserve's aggressive interest rate policies have diminished investor demand.
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"It seems that, for now, the projected deep deficit is being overpowered by the interest rate environment, as occurred back in 2022. Investment and interest rate flows often trump tight primary physical market conditions," Melek said in the report. "We argue that the roughly 1.3 billion oz of inventory (of which 60-70 percent is unallocated) can more than fill the gap in the coming months."
Along with higher for longer U.S. interest rates, Melek said that the silver market will also have to contend with growing economic weakness as activity starts to slow down in China and the U.S. continues to creep closer to recession.
"Demand weakness stemming from a poor macroeconomic environment is also a big reason that prices are to be weaker than many silver enthusiasts hoped. We also believe that a pending US recession and Chinese economic weakness will limit physical investment and industrial demand," he said.
Despite the near-term challenges, Melek noted that silver's long-term potential remains bullish. He added that there isn't enough mine supply for silver to meet the long-term demand trends.
"As demand associated with the electrification of the global economy grows, in order to fight climate change, it looks like the world will face persistent primary silver deficits over the long term. Silver uptake by the emerging EVs industry, smart devices, electrical grids, solar power generation and the conventional industrial products looks set to outpace the quantities produced by miners and recyclers," he said.
"If deficits persist for a prolonged period as expected, the inventory of above ground stocks will diminish to levels which will be too low to consistently provide the buffer against deficits. This implies very high prices, as the silver sector will operate above the conventional supply curve."
