The US Dollar index compares the relative strength of the Dollar against other major currencies. It doesn’t tell us how good of a job the Dollar is doing to protect your wealth or purchasing power. If you had the foresight to convert all your assets to Dollars around in late Spring 2008, then you would have spared yourself the losses that the financial meltdown has inflicted on investors. Very few people actually did that and most are sitting on large losses now. Along with many other precious metals analysts, the financial crisis did not surprise me at all. It is the inevitable result of a system of dangerously leveraged credit fueling an unnatural demand for consumption. What did surprise me is how poorly the metals, especially silver, protected one’s wealth during that time.

          Gold bullion has done a respectable job of maintaining an investor’s wealth, although it was looking very poor in October and November, down over 30% from it’s Spring highs. Mining stocks have been obliterated, along with most other resource related stocks, but many have doubled or tripled from their November lows. Silver has been treated like any other industrial commodity and lost 60% of its value from peak to lows last Fall. I was very mistaken in August that investors would see through the weaknesses in the US and push the Dollar back down. The truth is that the whole world is in rough shape and as crazy as it may seem, the Dollar may be one of the best of the lot of badly managed world currencies. I would not be surprised to see the Dollar index maintain strength. That does not mean that I think the best idea now is to keep your money in US Dollars!

          The US Congressional Budget Office is forecasting a Federal deficit of $1.2 Trillion for 2009. This is probably very optimistic. We are in a deflationary downturn caused by a collapse of leveraged credit. The current recession will be the worst since World War II and has the potential to turn into another Great (or Greater) Depression. The government will do everything in its power to prevent that from happening. The current economic theory is that deflationary downturns can be turned around if the government just spends enough money to make up for the lack of economic activity in the private sector. This theory has never been proven and never tried in a deflation caused by credit collapse (as opposed to a deflation cause by excess inventory and overcapacity in the private sector).

          Our entire culture and economic reality have been built on a lie; that we can use credit to consume more than we can afford, without saving for the future, and live off the savings of our trading partners overseas. What we really need is a further decline in still overvalued housing and stock valuations, an increase in the savings rate, a higher unemployment rate as bad businesses go under, and a time of painful adjustment to get back to a sustainable economy based on reasonable levels of credit. That is politically unacceptable. The government will do everything it can (this means borrow and spend as much money as they can get away with) to try to kick start the economy and bring back the easy credit that we depend upon. If this doesn’t tank the dollar than for sure it will cause a rise in the one form of money governments can’t make out of thin air – GOLD.

          Although it might seem like a contrarian indicator, more and more mainstream analysts are forecasting good times ahead for gold. There is a huge amount of cash sitting on the sidelines right now, waiting to decide what investments will produce a good return. Millions of retiring Baby Boomers will not be able to retire if they are earning only 2% on their investments. I think 2009 is the year that gold and precious metals investing will start to catch on in the mainstream. Already it is difficult to get physical delivery of small quantities of gold and silver for the average investor. When available, the premiums asked are much higher than the New York quoted spot price. If you can find physical gold and silver, buy it. That is the foundational insurance that will protect the value of your portfolio in the turbulent times ahead. If you can’t buy physical silver, then invest in top tier, low cost miners of gold and silver, or junior mining companies that are producing and have a good cash position. Gold and silver companies will be the next stock sector to renew a bull market, as most other companies will return marginal earnings for the next several years.

          Why do I still recommend silver, given its poor performance compared to gold since summer? Silver is still down 45% from its highs, while gold is only down 10%. Silver has rebounded over 35% from its lows, while gold is up about 28%. Typically, when gold goes up, silver goes up by a larger percentage. I think that will be the case again this year as investors focus less on silver’s industrial demand and focus more on its investment potential and lower cost to gold. Another factor is that about 80% of silver is mined as a byproduct of other metals mining. Many mines are being shut down or production curtailed for tin, copper, zinc, etc. I expect this will reduce the supply of newly mined silver in 2009. That should be enough to offset the reduction in industrial demand.

          I usually mention the number of silver futures contracts held short on the COMEX by commercial traders. In August I mentioned that there was still overhead of short positions that could drag gold and silver down further. While I was expecting that gold and silver would hold their value better during the financial chaos, in fact they did get sold to raise cash along with many other quality assets. The major overhead of commercial short positions is no longer there in silver and significantly reduced in gold. This chart shows that open interest (total contracts outstanding, blue line) is the lowest it has been since 2004. Non-Commercial long contracts (green line) is at a very low level, as it the Commercial short position (red line). These low readings always precede rallies for silver. Another way of looking at it is that there are fewer weak hands (speculators and non-commercial hedge funds) holding silver long that may be forced to sell. This paints a bullish picture for the metal going forward.

          The last time I posted my commercial traders’ silver Sum of $ Short graph, I expected it to drop into negative numbers, and did it ever! The indicator actually surpassed the lows hit in the credit crisis sell off in August 2007 with a two pronounced low readings coinciding with silver’s sharp drops in October and November. This indicator has been trending up. As the price increases, expect commercial traders to increase their short position accordingly. The commercials have to take the opposite side of the silver trade to hedge exposure for clients that may be exposed on the long side to the price of silver. For the past six months, commercial short contracts have an 87% correlation with the price of silver and commercial net short positions are showing a 92% correlation. Whenever this measure bottoms and reverses upward, it has been one of the most accurate indicators of the beginning of a new rally in silver.

Summary

          While it would be nice to go back to October and buy silver for $9.00 an ounce, or gold under $700, we can’t do that, and have to make the best decision going forward. Gold isn’t cheap right now, but I’ll wager that it won’t be cheaper this time next year. I expect gold will take out its previous high of $1050 before the end of March. Silver is still very low and presents an excellent buying opportunity. It has to kick the association with industry and gain mainstream attention (which gold’s ascent should facilitate) in order to take out its previous highs. I can’t say how soon that will happen but expect we will see silver in the $14-15 range when gold is setting new highs. Percentage wise, the price of silver should rise more than gold this Spring.

          Gold and silver moved up strongly this week and I’ll be watching how they trade when they reach the upper line of their current trend channels. $930 for gold and $12.80 for silver are the levels to watch. Assuming they break through the upper trend line, then gold will move on to test $1000, and then its old high of $1050, and silver will test resistance around its 200 DMA of $13.77. If they can’t penetrate the upper trend line, then we’ll have another opportunity to buy as they retest the lower trend. However, this is the time for seasonal strength for the metals and the ongoing financial crisis is offering investors few safe assets to protect their wealth and generate a decent return. You will hear and see more mainstream analysts talking about gold and this will be good for gold and silver. If you are sitting on cash now, get positioned or increase your exposure to gold and silver now. I am biased towards silver, as I expect greater percentage returns, but both belong in a well diversified portfolio.

Best wishes on your investing and future and God Bless,

Timothy Silvers

Disclaimer: This article represents the opinions and personal views of Timothy Silvers and is not intended to be investment advice. If you choose to use this analysis for your personal trading, Timothy Silvers assumes no liability for the direct or indirect losses you may incur due to using this article to make your investment decisions. You are totally and completely responsible for your own investments. At any given time, Timothy Silvers or his friends and relatives may have positions in silver related investments that may or may not follow the recommendations contained in this article. The information in this article may not be completely correct and accurate. Even though Timothy Silvers has done his best to review the content and accuracy of this article, he is in no way liable or responsible for any mistakes or omissions.