Silver’s rally higher has grown real legs thanks to a multitude of factors that are driving dollar softness and renewed risk aversion on a global scale. Even though part of the dollar weakness can be attributable to the lack of a timeline for the Central Bank’s normalization efforts, the data is also dragging on the currency and stimulating demand for alternatives like silver. With these factors expected to prevail over the short-term, silver’s momentum higher might be still in its early stage, especially if inflation rises further from current levels. However, there are some risks that could dent the upside thesis, especially in light of how the smart money is positioning itself and the potential for inflation to turn into deflation considering the global outlook.

The Dollar Factor

After surging to the highest levels since early 2015, silver priced in US dollars is benefiting from a number of weak spots both in the United States and globally.  With the dollar index falling to the lowest levels since January of 2015, silver has been able to capitalize on this weakness. Following the emphasis on “data dependency” in the latest FOMC decision and subsequent GDP print, finding the silver-lining in US economic data remains elusive.Unless there is a near-term recovery in underlying fundamentals such as manufacturing and spending, stronger employment metrics alone will not be enough to catalyze another interest rate hike. However, once the Central Bank does decide to raise rates, the stage is set for a dollar rebound which will likely temper gains in silver prices.

One of the less covered factors behind the meteoric rise in precious metals has been the rapid appreciation of the Japanese Yen which has propelled the dollar even lower. Following the decision by the Bank of Japan to abstain from expanding the existing Quantitative and Qualitative Easing program, the Yen has strengthened dramatically, climbing over 400 pips versus the dollar on April 28th alone. With USD/JPY falling at the fastest pace since 2010, the lack of a direct intervention in the currency akin to the ones implemented in earlier months, has set the stage for another rally higher in silver prices, especially if the currency pair should fall through the critical 100.00 psychological level. Combined with a stronger Euro, these factors continue to pressure the US dollar to the downside.

A Solid Currency Insurance Policy

Although many have spent time analyzing silver’s potential for preserving wealth, storing value, and hedging against inflation and rampant fiat money printing, the key missing from this argument is that silver already acts as currency.It is readily transferable, divisible, and most notably physical, not a string of numbers on a screen or a piece of paper insuring a claim to the physical.While analysts may be correct in their assertion that silver is a non-productive asset, the asset should be reframed as a currency or equivalent that can appreciate or depreciate over time. The widely held view of silver as investment is challenged by the fact that it does not pay interest and bears more a resemblance to a currency than stocks or real estate.Notwithstanding the practical features of holding precious metals, silver is also accepted globally as a currency equivalent.

The Speculators Versus Commercial Hedgers

Upon further review of the latest Commitment of Traders (COT) report released weekly by the Commodities Futures Trading Commission, some interesting factors come to light.According to the figures tabulated through April 26th, there are 177,300 long open contracts in silver futures, marginally outweighed by the 189,829 open short contracts.The breakdown of who is net short and net long is where it really counts.For one, short commercial positions, namely hedging for companies mining silver, are at the highest levels on record, totaling 148,002 contracts.The reason this group is called the smart money is owing to the fact that these institutions have an actually need for hedging, not speculating on price fluctuations.On the flip side of the coin, speculative long positions have also climbed to a record 99,774 contracts.The fact that these two positions are trading at extremes may signal an impending reversal in prices.

Upside Targets

While banks and sell-side analysts are growing extremely bullish on silver prices, targeting $20 per troy ounce, there may be some factors that disrupt the current rally. For one, much of the current appreciation in silver prices has been predicated on underlying dimness in the US dollar. While no new normalization efforts are imminently expected from the Federal Reserve, a pickup in fundamental data could spark renewed speculation of another rate hike.If the hike comes sooner rather than later and is set to precede an ongoing cycle of interest rate increases, this could spur a rapid turnaround in the US dollar.Outside of pressuring the dollar, higher rates would help temper existing inflation, hurting silver’s demand as a hedge. Additionally, should the global deflationary wave remain intact, it could reduce silver’s shine from practical perspective.

Even though trend followers will eagerly get involved in the silver trade, the COT report underlining the fact that speculators have never been longer could also be a risk factor that upsets the upside thesis. With commercial hedging also rising to a record, the variables determining prices might have a slightly bearish bent considering they believe the top might be in, causing the market to rapidly approach a potential tipping point.While near-term silver may have further room to run higher, on a longer the timeline, the uncertainty about policy and inflationary developments could throw a wrench into the rally, snuffing it out just as quickly as it began.