What If the U.S. Dollar Crashes Overnight?
This essay is based on the Premium Update posted on June 11th, 2010.
One of the questions that we've 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, since these three sectors traditionally move together.
The answer is the 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 metal market is not 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 (as featured in the "Top or Not?" list in the Tools section on our website) that will tell us that this is indeed the ultimate top - we don't see them yet.
The declining general stock market may continue to put a negative pressure for mining stocks and (especially) silver until we get to the final stage of the bull market (actually, we expect high rates of return even from stocks that don't mine gold nor silver, but that are just named "golden something" or "silver something".) In case of silver, we might also see sharply higher values in case of a problem with delivery of silver on COMEX. However, until either of them takes place, we might continue too see underperformance of these two parts of the precious metals market if the world stock indices move lower.
In case of silver, we 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 would allow to 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 are 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 does not change the fundamental situation for the whole precious metals market, and consequently, does not make us concerned, as there is a good explanation behind it in the form of declining stock market.
There's one more thing that we would like to comment on in this essay, as we've been also asked about the final stage of the rally, and what would be the use of the having massive gains on one's mining stocks, if they would be priced in the U.S. Dollar that could be worthless at that time. That is true that the final stage of the bull market in the precious metals market could correspond to a financial instability to say politely, but fortunately we are in this market to maximize our chances of even 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 U.S. Dollar collapses overnight" and the second one would be about the gains in mining stocks when the U.S. 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 it is spread among several "safe places", it seems that you could sleep well at night. If the USD collapsed overnight, the increase in the value of the precious metals holdings would be so massive that just a 10% in gold/silver should more than make up for the losses in your "paper wealth." So, by following the rules listed in the Key Principles section you would 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 does not need to overly concern you either, because - as mentioned above - mining stocks are not likely to outperform metals during the final stage of the bull market. Therefore, we will strive to detect when it is not likely that mining stocks' outperformance will not return soon, and we will suggest switching directly to metals, just like we are 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 we believe that the bull market is close to being over.)
This is not recommended for most Investors, because could decrease one's profitability, but if you are particularly afraid that you could lose your speculative capital because of the death of the U.S. 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 will 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 is likely to go is still up, and if you prepare yourself 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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Thank you for reading. Have a great and profitable week!