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While I have warned for quite some time that QE-Infinity was not going to be the savior everyone expected for the metals, many scoffed. Many thought I was foolish. And, the fact that I even gave a specific level which would contain any rally in silver at that time (which held within 9 cents) was viewed by many as preposterous.

Well, we all know what has happened to the metals since QE-Infinity has been announced. But, most do not understand why. Those that point to the notion that QE has increased the money supply but has not had an effect upon money velocity are looking in the right direction, but that still does not explain the "why," nor does it even come close to providing accurate targets for the metals. So, let's try to understand the "why" and maybe we can get a better understanding of when we will see silver start to rally.

Definition of Inflation

As defined by Webster's Dictionary:

Inflation is a persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money caused by an increase in currency and credit beyond the proportion of available goods and services.

Written in a calculation format, we would present it as follows:


In its simplest form, inflation is CAUSED by CREDIT/MONEYBASE EXPANSION. If you think about it, if everyone has more ability to buy goods because there is more money/credit for them to do so, then the cost of the limited number of goods available must go up based upon the law of supply and demand. Of course, the opposite is true as well.

Pervasive Misconception of Inflation

How is a determination of "inflation" actually arrived at by many of our experts today? We hear many pointing to the CPI or the PPI rising and then claim that we have inflation. We hear many more pointing to energy and food prices rising and claim that we have inflation.

Yet, these same "experts" seem to dismiss the declining real employment statistics, the declining relative housing statistics, and the declining consumer debt statistics. They claim that these declines are happening for "other" reasons.

But, is the fact that we see certain prices rising (as others are declining) a reason to cry from the top of the financial peaks that "inflation is upon us!?" Let's analyze the definition of inflation a little more closely and see if these cries for inflation are truly warranted.

A Closer Look at the Definition of Inflation

Whenever we analyze definitions, such as the one for inflation, we have to understand that there are two aspects to the equation; one is the cause, and the other the effect.

INFLATION CAUSE: an increase in currency and credit beyond the proportion of available goods and services

INFLATION EFFECT: a persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money

Keep reminding yourself during this exercise that inflating prices is an EFFECT of the definitional cause, and not the determinative factor in making the case for inflation. In order to determine if this effect is actually pervasive in the market and can be termed "inflation," we need to determine if the CAUSAL side of the equation actually exists. Ultimately, we need to see an increase in currency or credit which is outpacing ALL available goods and services in the economy in a relative manner.

We have all heard the term that "a rising tide raises all ships." This is exactly how inflation works. Again, if more people have more buying power through possessing additional greenback notes or additional credit, then the prices of ALL the limited available goods and services in the economy, as a whole, should be rising.

Yet, we have some asset prices which are soaring, while other prices have been declining. But how can some asset prices really be declining if there is true inflation, which is supposedly caused by more "money" to buy all assets? Shouldn't the additional purchasing power, if it truly exists, cause ALL asset prices, including the metals, to rise in a true inflationary bout?

It seems to me that most analysts are only looking at the effect side of the equation and ignoring the causal side of the equation. But simply identifying price appreciation in some assets is not how we appropriately define inflation.

Quantitative Easing Effect

What most people do not comprehend is that the Fed and government are not in complete control of credit expansion, whereas they absolutely can control money expansion. I know this is completely counter-intuitive to what we are led to believe, especially when viewed in light of the common, but inaccurate, perception of QE.

The Fed has the power to print actual dollar bills and flood the system with actual physical currency or "greenbacks." This is a simple way that they can attempt to cause inflation, since more actual money in the system will put pressure upon the limited goods and services available in the market. However, this is clearly not the path they have chosen for numerous reasons, and it will probably be the path of last resort, which will only be embarked upon after deflation has ravaged the system.

The manner in which the government has been attempting to affect the monetary base is by injecting available credit into the system. They do this by a process termed "monetization of debt." The Fed acquires Treasury issued debt instruments in the open market, and then issues the seller bank a "credit" on its books for the acquisition price in its Fed account. In effect, the Fed simply creates a book credit on the bank's balance sheet that did not exist before. It does not send cash to the bank. Since it never retires the debt instruments it acquires, it is simply adding available credit to the monetary base by these acquisitions and extensions of credit to the seller banks.

The problem with an attempt at creating inflation through an available credit expansion method is that there has to be not only a willingness to issue credit, but also a willingness to maintain or even accept further credit expansion by the public. For if the public is deleveraging at the same time that the Fed is attempting to expand the credit base, then the Fed is fighting an uphill battle it cannot win.

I think the one thing we have seen since we hit the bottom in the equity markets is that consumers have not been willing to accept credit expansion to any significant degree. In fact, the weight of evidence shows that they are continuing to deleverage, as we can see from the simple chart below:

(click to enlarge)

Therefore, the government's attempt to "impose" inflation by attempting to inject available debt into the system cannot, by definition, work in a society that is in the midst of a debt deleveraging trend, either by choice (not accepting further debt, or reducing its current debt load), or by force (default). So, as long as the consumer at large is not "buying" the additional credit available, then the credit available does not make it into the system to put pressure on inflationary forces.

So, now that we understand the mechanics of inflation, or, rather, lack thereof, we can move to the "why" the public at large is not "buying" the additional credit available. Again, as many of you know, I am an Elliottician at heart. What Elliott Wave principles show is that once a 5 wave move in public sentiment is completed, then it is time for the subconscious sentiment of the public to shift in the opposite direction, which is simply a natural cause of events in the human psyche, and not the operative effect from some form of "news." This has been proven time and time again throughout history. This is the basis behind the Elliott Wave and Phi concepts; concepts which have been understood by Plato, Pythagoras, Bernoulli, DaVinci and Newton, as well as all the way back to the architects of the Giza pyramid in Egypt, who recorded their knowledge of Phi as the building block for all man nearly 5,000 years ago.

This idea that has shaped the composition and actions of all living creatures is inherent in the spirit and activities of humankind, taken as a whole. Based upon these concepts, it is clear that man's progress does not take the form of a straight line, nor does it occur randomly in nature. Rather, it progresses in 3 steps forward, with two steps back. This mass form of progress seems to be hard wired deep within the psyche of men, and that is what we have come to know today as the "herding principle."

Bernard Baruch, an exceptionally successful American financier and stock market speculator, who lived between 1870-1965, put it best when he stated:

All economic movements, by their very nature, are motivated by crowd psychology. Without due recognition of crowd-thinking ... our theories of economics leave much to be desired. ... It has always seemed to me that the periodic madness which afflict mankind must reflect some deeply rooted trait in human nature - a trait akin to the force that motivates the migration of birds or the rush of lemmings to the sea ... It is a force wholly impalpable ... yet, knowledge of it is necessary to right judgments on passing events.

Therefore, the attempt by any entity to truly affect such a natural and deeply embedded form will be ineffectual and be deemed "discounted." Therefore, my position is that QE3, 4, 10, etc., or any other form of government action will ultimately not be able to affect the direction of the trend, which is based upon social mood. So, in my humble opinion, this is why we have not seen the public "buy into" the credit expansion efforts of the Fed, and why the velocity of "money" has not increased even though a significant amount of additional credit has been made available through the Fed's efforts. Simply put, the public has no more appetite for credit expansion after completing a 70 year credit expansionary 5 wave phase. And, once the 5 waves completed, it is now time for the 3 wave counter-trend move in the opposite direction, i.e., credit contraction.

The Dollar Effect

So, thank you for allowing me to digress, and now we can focus on the recent loud voices that claim that silver will surely move up when the dollar begins to decline. Well . . . this past week, the dollar has seen one of its steepest declines in the last year. So, of course, silver should be higher than it was last week. But, wait. Silver dropped over 6% as the dollar plummeted.

Well, the last two years should have taught you that all the "reasons" for silver's rise or fall have only led investors astray. And, if you have not learned that yet, then you have simply been investing while wearing blinders and will likely not learn now. Yet, when you finally come to the realization that the metals are moved by sentiment, and most commonly, the sentiment of fear, then you will have started down to the path to being able to identify upcoming moves in the metals.

But, some assume that the fear of inflation is the only fear that will move silver. Remember, there are many reasons that society begins to fear. There is the fear of war, the fear of famine, the fear of social upheaval, the fear of financial collapse, and many other fears which can move silver. But, you need to understand where silver is in relation to the overall sentiment picture to know when the time is ripe for a fear to grip buyers or sellers of the metals. And, we are getting much closer to such a moment right now.

Based upon my sentiment analysis using Fibonacci mathematics and Elliott Wave, as long as silver remains below the 23.05 resistance level that I cited weeks ago (which actually held to the penny two weeks ago), then I am going to expect to see a 19/20 handle on silver before we see a larger recovery rally up over the 25 region. But, that rally will likely also be sold for one more low later this summer or early fall. Yet, I will maintain an open mind that the next low we see may be the final low before a very strong rally in the metal. Only time and wave analysis will tell. But, I will be adding to my net long long-term long position on this drop and treating it as if it were the bottom, and still leaving some "dry-powder" available for another low later this summer or fall, or for a confirmed break out, whichever comes first.

Source: What Really Happened To Silver: A Different Perspective

Additional disclosure: I have SLV puts as a hedge for this decline.