Silver and the US Dollar

August 2, 2004

Over the past two weeks or so, there has been a surge in interests on the US Dollar. In particular, the relationship between the Dollar and precious metals. Since gold and, especially, silver prices had been widely discussed to be manipulated, the Dollar's price action may have significant impact on the prices of silver and gold between now and when both metals' prices are set free.

Before we dive into the fundamentals and technicals of the Dollar, it's important to recognize that the Dollar may not (or soon will not) trade in a free market fashion either. There are just too many vested interests at this point around the world to avoid a Dollar collapse. Brian Bloom's work, "Managed Markets", provides an elegant argument.

I agree with Bloom that the worlds' central bankers will do all it can to prop up the Dollar and suppress gold and silver price. The only thing I disagree is that the central bankers will manipulate, not manage, the Dollar. The Webster's Dictionary definition of "manipulate" is "to manage or influence skillfully, especially in an unfair manner." Therein lies the difference between manipulation and management. Manipulation contains an element of deception. Do I need to remind you the widely discussed possible government deception in inflation and employment statistics?

The practical aspect of distinguishing manipulation and management is to answer the question: To what extent can analysis, technical and fundamental, still remain useful in a manipulated market? Remember that the global central banking establishment will not only do what it can (ability to print an unlimited amount of any paper currency), they will also do anything, regardless of the actions' legality or morality. In this line of thinking, I agree with Bloom andDoug Nolan that this, indeed, is "an exceptionally challenging analytical environment." All analysis may temporarily be useless.

Nevertheless, there are a few points that speculators and investors in silver may take to navigate through this storm.

First, eliminate leverage. This means only physical silver. And never buy silver stocks on margin. I cannot emphasize this enough. If the volatility is going to be huge and illogical (therefore unpredictable), why increase your risks?

Second, focus on the long-term. All "managed markets" will come to an end. So do "manipulated markets." The managed markets will have longer life span, as in government regulated natural monopolies (e.g. hospitals). But manipulated markets may end sooner. This is because deception, if revealed, will certainly accelerate the death of manipulated scheme. Therefore, it's crucial for investors without precious metals positions to begin building a silver position.

Third, take advantageous of short-term weaknesses. This involves paying attention to both fundamentals (in the form of news events) and technicals of Dollar and precious metals market. An example of this is last Tuesday's (July 27) stronger than expected July Consumer Confidence Index, reported to be 106.1, a two-year high. From the following US Dollar Index daily chart, July 27th is also the day the Dollar exhibits tremendous technical strength by closing above two important moving averages (100 and 200 day moving averages) simultaneously.



But note that the Dollar began strengthening several trading days before the Tuesday's good number (dotted, upward sloping trend line). The Dollar strength also roughly corresponds to silver's weakness. Marked by dotted, downward sloping trend line on the silver daily chart below.



With the guess (and it's only a guess) that the central banking establishment active manipulating Dollar and precious metals markets, investors may continue to observe a somewhat asymmetrical price action to news events in the short-term. Asymmetrical in that news favorable to Dollar will materialize into sharp price appreciation for Dollar and sharp price depreciation for silver. On the other hand, news event unfavorable to US economy or Dollar may notnecessarily result in Dollar depreciation/silver appreciation as under normal (i.e. un-manipulated) case.

In fact, by last Friday, Q2 GDP reported to be annualized 3%, significantly below analysts' estimate of 3.6-3.7%. Note the side-way price action on the above daily Dollar Index chart, from Tuesday to Friday, in the face of this bearish announcement. Silver behaved normally this time, with price strength. However, it's important to remember that in a manipulated market, silver price may stay down, or even go down, with Dollar-bearish news. Making such type of news unsuitable for selling silver but buying silver (or adding to silver position) in the face of temporary weakness from Dollar-bullish news is recommended.

Note that silver purchasing decision is made on ex post basis. This is because price action will be underway to reflect the Dollar-positive news before they were announced. For this example, the purchase can be made at late trading session of July 27th or early trading session of July 28th. In short, purchase is made after the silver has discounted the Dollar-bullish news.

A (possible) Play on Silver

The housing bubble is becoming a popular topic again. My guess is that somewhere in the near future, there may be a "deflation scare." However, a monetary system central bank with paper fiat money, which is what we have now all over the world, deflation can never occur. Only more and more inflation (please see Ed Bugos' "Inflation versus Deflation").

Central bank may use this "deflation scare" (from the puncture of housing and mortgage bubbles) to prop the Dollar and suppress silver and gold price. For those who don't have a silver position, this down leg is a good opportunity to build a position. As for those who already own silver and/or silver stocks. This is also a good opportunity for planned addition.

DISCLAIMER: The author is not a registered stockbroker nor a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible sources. Of course, the author recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, we encourage you confirm the facts on your own before making important investment commitments.

The melting point for silver is 961.93 °C - 1235.08 °K