I have found citations from ancient texts backing both interpretations on the Internet while searching for the correct form of the term:




Which of these is/are correct?


Both are correct. According to http://www.zdic.net,



察:详审(scrutinize)。言:言语(speech)。观:看(look)。色:脸上表现的神情(expression on face)。
So it means dive sb.'s thoughts from what he says and the expression on his face.



Note it's a little different that here's only watching expression on sb.'s face, no listening the speech.

And 漫说“察言观色”与“察颜观色”,



言 means words, what you say 颜 means face originally, and here it refers to emotional expression on your face

both are reasonable 察言观色 means be aware of what you say, and your emotional expression on your face 察颜观色 means be aware of your emotional expression on your face

颜 and 色 here both means emotional expression on your face. 察颜观色 is a repeating of the same thing, also a Chinese rhetoric of 互文 (describe repeatedly)

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