"I've loved her through the years and watched her grow up, and I've seen how smart she is and how talented she is," the country music star said.
"I don't think people really realise yet what a great singer and writer she really is," the 67-year-old told the Evening Standard.
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Dolly insisted that she didn't need to give Wrecking Ball singer Miley career advice, saying, "She's just trying to find her own place and wings and learn to fly."
Former Disney star Miley hit headlines after her provocative performance with Robin Thicke at this year's MTV Video Music Awards.
She has since come under fire for racy photoshoots and videos.
Miley's father Billy Ray Cyrus is a good friend of 9-5 singer Dolly and made her Miley's godmother.
Dolly insisted that she would be there for her goddaughter if she came to her. "If she needs my opinion on something I will surely give it and there have been times we've talked.
"But I would never dream of calling her and saying, 'Well why are you doing this?' or, 'You shouldn't do this or that'.
"I know that she has thought this all through. We'll let her go and do her own thing."
Dolly, who is currently on tour, said that she would like to perform with the Party In The USA songstress.
"I would love to do some duets with her. I would love to sing with her and write with her because I think she is so gifted.
"It's not easy being young. It's hard to know what to do. You've almost got to sacrifice your damn soul just to get anything done."