-- Posted 26 January, 2009 | | Discuss This Article - Comments:

Silver continues to lag behind gold as the two metals in general struggle against this deflationary setting. Gold has benefitted from some of the fears regarding the stability of the credit and banking system but not enough to propel it to new highs.

The counter-asset to gold and silver – the US Dollar – continues to enjoy its season in the sun as mass redemptions and fund liquidations force investors to park their wealth into the safest perceived asset during a deflation and that is cash. Indeed, a look at a graph of the US Dollar Index (in red) versus the S&P 500 since this credit crisis began shows a recent negative correlation between stocks and cash.

Prior to the market panic, the markets and the dollar generally drifted down together but once the realities of this financial crisis began to set in with some big hitters getting clobbered themselves, the dollar began to take off in an inverse direction to equities. Note the dollar surges as the bad news hit the headlines. Once the big equity sell off finished in November, we had a rally and the dollar sank as a safe haven albeit temporarily. But the news then shifted to the effects of the credit crunch and that is the news that now dominates – recession and mass layoffs across the board.

Where do people park their assets during recession? The answer is cash or its nearest derivatives and that is how things are panning out just now. So how does this bode for silver? The chart below shows how silver is struggling to get any head of steam up in this environment.

Since the dollar topped in November, silver has put in a 45% appreciation and has retraced about 29% of its crash from $21.34 to $8.47. Meanwhile gold has just about retraced a Fibonacci 62% of its down move. Clearly, silver’s role as an industrial metal is dampening its role as monetary metal as commercial silver users cut orders to refineries and work off their excess inventories.

As you can see, silver broke above short term resistance (the horizontal line) but faces a stiffer test in the rising channel that has existed since late October. That line will be met at around the $12.30 to $12.50 region at which point silver could conceivably collapse down to the lower channel line near $10 or lower. It all depends on the dollar though we have had the unusual situation of the dollar, gold and silver all rising together recently. That is not a sustainable situation and is a tension between precious metal investors anticipating a break down in the dollar rally but also dollar bulls expecting another flight to cash as the stock market recommences its drop to new lows.

Perhaps the two camps will cancel each other out and we will see the dollar being range bound for a while. That will only be answered when the stock market begins a drop to possibly the 500-600 level. The conclusion is this, volatility rules and hence silver is a traders’ paradise (experienced traders that is!) and while recession remains it will stay that way. Longer term investors in silver should still be buying into silver at these very low prices in anticipation of a new bull taking hold when recession ends and the trillion dollar bailouts begins to bite in terms of inflation further down the line.

Further analysis of silver can be had by going to our silver blog at http://silveranalyst.blogspot.com where readers can obtain a free issue of The Silver Analyst and learn about subscription details. Comments and questions are also invited via email to silveranalysis@yahoo.co.uk.