“Dollar Up, Gold Down” or “Dollar Down, Gold Up” is a common one in the Gold investing community. This works until it doesn’t. The funny thing is that THE MOST IMPORTANT BULL RUN IN THE LAST CENTURY FOR GOLD PROVES THIS ISN’T A GOOD WAY TO LOOK AT GOLD! I am not making this up. This is actual market history there for anyone to examine. But most instead steadfastly stick to simple phrases that cannot possibly capture the nuances of the complex human psychology that backs market behaviors.

Here is a chart including the most important and legendary move in Gold that every Gold bug has seen a picture of (stolen from chartsrus.com):

During the 1979 to 1980 parabolic run when Gold more than quadrupled in about a year, do you think the U.S. Dollar collapsed? Well, it obviously went down a lot, but we know it didn’t collapse, right? Here’s the chart of the rapid but not catastrophic collapse in the U.S. Dollar Index from 1978-1980 (again, stolen from chartsrus.com):

If only markets were so simple that basic phrases describing intermarket relationships could make you rich. Ahhh, we can dream can’t we? So if you really want to get rich in Gold, I guess you should buy Gold when the Dollar is rising.

Those thinking that a rally in the U.S. Dollar Index, which is an abstract index comparing anchorless paper to anchorless paper, can stop the secular Gold bull market don’t understand Gold or secular bull markets. Secular bull markets become self-perpetuating momentum machines that shrug off “bad” news and power higher anyway. The U.S. Dollar Index rose 50% between 1995 and 2000, but did that stop the secular general stock bull market or cause a collapse of the internet tulip mania? Absolutely not. The secular bull market in Gold will keep on going until we get to the public mania phase, after which it will collapse on its own weight, irrespective of the U.S. Dollar Index. I am betting this will happen after the Dow to Gold ratio gets to the 0.5 to 2 range.

It goes like this…. “As soon as the Fed raises rates, it will pop the Gold bubble and the US$ will bottom”

This is totally ridiculous. First, it is real interest rates that matter. Rates need to be 2-3% above the level of inflation. So right now, even if you say inflation is 0% or 1%, rates would need to go up to 2-3%. Secondly, rising rates usually follow the price of gold. It was true in the 1970s and is probably true when you look at the price of Gold in other countries. Rates rise because people don’t trust paper. Rates have to rise high enough for people to abandon hard assets and trust paper again.

Based on this factual analysis, the Fed will have to hike rates aggressively. They have never raised rates when unemployment has been rising. Even by their own admission, they won’t raise rates anytime in 2010. And why would they begin to hike aggressively when the economy is approaching zero hour and maintains no real growth of any sort?

Also, we didn’t factor in the currency weakness. Most people expect the US$ to lose value. If it loses 5% a year and inflation is 2-3%, then rates really need to be 10% to poke the bull in Gold. What is more likely for this scenario is that the Fed says inflation is 2-3% and they can tolerate it now because a weak US$ and low rates will help the economy. Therefore they’d keep rates under 1%, even though its obvious the economy is hitting zero hour- the point where new debt is not creating any real growth.

This argument is just total nonsense. Again, it is just a sound byte you hear on CNBC from the same analysts who have gotten everything wrong. They throw this out there, along with other BS, without even looking at the facts. The interest rate argument is at the bottom of a list of concerns for Gold investors.

I own some physical silver but hold much more Gold. My concern is simple. In past deflationary cycles, Gold has done well but silver not as well. Since I favor deflation over inflation for this cycle, I heavily weighted myself towards Gold and only hold a little silver. I even made the stupid mistake of shorting silver a few months ago and had my a$$ handed to me.

Silver made a big move today and a short-term break out. Silver can make explosive moves up and down and with a push slightly higher, silver will have a confirmed breakout that targets new highs for the decade. Unlike Gold, silver is still a ways from its all-time nominal high around $50 during the last silver bull market in the 1970s. If silver makes new highs in the next few months, the deflation scenario won’t be looking so good.

Though I have believed deflationary forces were too powerful to be overcome by government intervention, global capital flows and/or an insane level of intentional wasting of money may prove to be too much. If silver breaks out to new highs for the decade, the deflation argument is going to look mighty thin. I remain hedged with Gold, as an inflationary holocaust means that Gold will peak in the $5,000-$20,000/oz range instead of the $2,000-$3,000 range. Either way, Gold holders will win over general stock holders. However, in a heavy inflationary environment, I believe silver has greater upside potential than Gold. Needless to say, I am going to hang on to my remaining physical silver until I see how this one plays out.

Here’s a daily chart of the silver ETF (ticker: SLV). This ETF doesn’t hold the silver it claims to and is believed fraudulent, but is being used for charting purposes because it can show volume. Silver bulls are advised to hold physical bullion as their core holding. I am not saying this ETF can’t be used for short-term trading, but paper is paper and metal in your possession is metal in your possession. Anyhoo, here’s a one year daily candlestick chart of SLV:

Here is a long-term weekly chart of silver ($SILVER):

Mr./Ms. Market is always right and those of us trying to keep up with him/her have to be flexible. I am learning not to fight the tape and instead embrace it. If my deflationary stance proves wrong and the government bond market is no longer relevant, so be it. As a Gold holder, it doesn’t matter to me – heads I win, tails I win more. Silver is on the verge of sending out a powerful warning to the deflationists to reconsider. If it occurs, I’ll be among the first skeptics to give it props and respect the move. If it doesn’t, I promise not to act like I saw it coming all along, as today’s move in silver was not what I expected.

You’re not going to hear inflexible Prechter-like deflationary dogma from me if silver breaks out to new highs for the decade. The Dow to Gold ratio is my secular compass, not the inflation-deflation debate. We should know within a few days whether or not this move in silver is the real deal. Perhaps I’ll have to start digging into, researching and expanding my junior silver miner stock list sooner than I thought…