Silver Celebrates the Dollar Doldrums

Will a slumping dollar help silver soar, or is the crowd re-enacting their mistakes from 2021 and 2022?

The USD Index has become a pariah, and silver couldn’t be more happy. However, the pessimism plaguing the greenback is much more semblance than substance, and it’s likely only a matter of time before King Dollar reclaims its throne. 

To explain, the EUR/USD accounts for nearly 58% of the USD Index’s movement. Consequently, it’s the most influential currency pair in the basket, and its recent rally has driven the index’s drawdown. Yet, euro optimism contrasts the realities on the ground, and the bulls should suffer mightily in the months ahead. 

Please see below:

The green line above tracks the EUR/USD, while the red line above tracks Citigroup’s Eurozone Economic Surprise Index. For context, a positive ‘surprise’ occurs when a data point outperforms economists’ consensus estimate, while a negative surprise is the opposite. And if you analyze the right side of the chart, you can see that the red line has crashed, as Eurozone economic data has come in much weaker than expected. 

Benefiting from Euro's Uprise

Therefore, while gold benefits from the euro’s uprising, the ominous fundamentals plaguing the Eurozone should come home to roost and uplift the U.S. dollar. 

As further evidence, the German ZEW Economic Sentiment Index declined by 6.2 points MoM, falling to -14.7 in July. ZEW President Professor Achim Wambach said:

“The ZEW Indicator of Economic Sentiment is shifting even more noticeably into negative territory. Financial market experts predict a further deterioration in the economic situation by year-end. A key reason for this is the expectation of rising short-term interest rates in the eurozone and the USA.

“Additionally, important export markets like China are seen as relatively weak. The industrial sectors are likely to bear the brunt of the anticipated economic downturn, with profit expectations for these export-oriented industries experiencing a substantial decline once again.”

Thus, while no one cares right now, investors’ appetite for European risk assets should come under immense pressure over time, and the USD Index should be a primary beneficiary. 

Please see below:

To explain, the black line above tracks the monthly movement of the iShares MSCI Eurozone (EZU) ETF, while the red line above tracks the German ZEW Economic Sentiment Index. As you can see, when weak economic sentiment plagues Europe, its stock markets suffer mightily. 

Yet, if you analyze the right side of the chart, you can see that the EZU ETF closed at a new 2023 high on Jul. 13, while the ZEW ESI has materially diverged. However, since 2009, the EZU ETF has not been able to prosper when the ZEW ESI crashes and this time should be no different. 

To that point, please turn your attention to the blue line at the bottom, as it tracks the USD Index. If you analyze the vertical gray lines, you can see that when the EZU ETF peaks and begins its descent, the USD Index bottoms and begins its ascent. 

So, with the ZEW ESI an ominous indicator of what’s to come for the EZU ETF (European stocks), the former’s decline should intensify as the global liquidity drain continues, making the divergence even worse. Therefore, don’t be surprised if the USD Index has the last laugh.

Macklem Musings

While the crowd assumes the inflation battle has already been won, these same folks thought a pause meant the BoC’s rate-hike cycle was over. Although, with Fed officials still immensely hawkish and demand proving resilient, BoC Governor Tiff Macklem (Canada’s Jerome Powell) said on Jul. 12:

“Higher interest rates are needed to slow growth of demand in the economy and relieve price pressures. But even as headline inflation has come down largely as we forecast, underlying inflationary pressures are proving more persistent than we expected.”

Thus, with base effects over in the U.S. and Canada, and lower oil prices a thing of the past, the crowd is celebrating when the easiest part of the inflation fight is now over.

Overall, asset prices have decoupled from economic reality, as the S&P 500’s profound rally has impacted other areas of the financial markets. And while stock investors are known to price in unrealistic expectations, misguided optimism has seeped into the bond, FX, and commodities markets. However, unanchored inflation does not abate alongside loosening financial conditions, and we believe this cycle doesn’t end without a recession. 

Do you think the euro rally has legs?

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