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What If the US Dollar Crashes Overnight?


How to protect your portfolio based on your level of risk and current market actions.

One of the questions I received last week was about the possible non-confirmation between gold at new highs and both silver and stocks lagging well beneath their old highs. The question is if such a non-confirmation becomes a source of worry at some point because these three sectors traditionally move together.

The answer is one that every economist likes to give when being asked just about any question: it depends. In the long run, fundamentals drive prices of assets and the precious metals market isn't an exception from this rule. As long as fundamentals are in place, the bull market in the precious metals will continue. There are several signs that will tell us that this is indeed the ultimate top -- I don't see them yet.

The declining general stock market may continue to put a negative pressure on mining stocks and (especially) silver until we get to the final stage of the bull market (actually, I expect high rates of return even from stocks that don't mine gold or silver, but are just named "golden something" or "silver something"). In silver's case, we might also see sharply higher values in case of a problem with its delivery on COMEX. However, until either takes place, we might continue to see underperformance of these two parts of the precious metals market if the world stock indices move lower.

In silver's case, I don't think it would invalidate its final rally or make it anything less than breathtaking, but it could certainly delay it. In a way, lower values of the main stock indices are good for long-term silver investors because they can buy as much silver as possible at relatively low prices before the silver market takes off.

As for the mining stocks, the situation is quite different, as they're not that likely to outperform metals during the final stage of the rally. However, in case of gold and silver stocks, the history suggests that the positive correlation with the general stock market is likely to wear off sooner or later. Please note that from 2001 to 2003 gold stocks managed not only to rise, but also to outperform gold along with declining stock market.

Therefore, the disproportion between gold's performance and the one of silver and mining stocks doesn't change the fundamental situation for the whole precious metals market, and consequently, doesn't concern me, as there's a good explanation behind it in the form of the declining stock market.

There's one more thing that I'd like to comment on in this essay, as I've also been asked about the final stage of the rally and what would be the use of having massive gains on one's mining stocks, if they'd be priced in the US dollar that could be worthless at that time. That's true that the final stage of the bull market in the precious metals market could correspond to financial instability, to say it politely, but fortunately we're in this market to maximize our chances of increasing our wealth during these difficult times.

Let's split the above question into two separate matters. The first one is "how do I know that I won't lose everything I have if the US dollar collapses overnight" and the second one would be about the gains in mining stocks when the US dollar is worthless.

The first question is all about owning physical metals. If you own physical metals, keep them in a safe place, or even better, spread them among several safe places. If the USD collapsed overnight, the increase in the value of the precious metals holdings would be so massive that just 10% in gold/silver should more than make up for the losses in your "paper wealth." So, by following some key principles, you'd have about 20%-25% of your portfolio in physical metals and an overnight dollar collapse could in fact massively increase your wealth. Therefore, you're protected at all times.

The second question is about protecting one's profits in mining stocks or from other speculative vehicles. Generally, it doesn't need to overly concern you either because, as mentioned above, mining stocks aren't likely to outperform metals during the final stage of the bull market. Therefore, I'll strive to detect when it's not likely that mining stocks' outperformance will return soon, and I'll suggest switching directly to metals, just like I'm now suggesting owning gold instead of silver and mining stocks (of course this is because of the short-term uncertainty regarding the last two markets, not because I believe that the bull market is close to being over.)

This isn't recommended for most investors, because it could decrease one's profitability, but if you're particularly afraid that you could lose your speculative capital because of the death of the US dollar, you might want to put 10%-90% of your profits from each trade (depend on how afraid you are) in mining stocks directly to physical gold or silver. In this way you'll be sure that the relative amount of physical metals in your possession is constantly rising, and at the same time the amount of "paper wealth" at risk (here: stocks) decreases. Again, the price here is limiting your exposure to profits from speculation on mining stocks, so it's a trade-off.

Summing up, the long-term direction in which the precious metals are likely to go is still up, and if you prepare accordingly, you should be able to preserve your wealth and probably even increase it, even if the current financial system would cease to exist in the current form. Meanwhile it might be a good idea to earn money along the way by trading gold, silver, and mining stocks.

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