Q&A with Larry Edelson

Today’s column is going to cover two topics. First, I’m going to answer some of the most recent questions I’ve received regarding the economy and key markets.

Then I’m going to discuss with you some principles I’m using with my own money in my trading.

So, let’s get started …

Q: Larry, the economy seems to be rolling over again, so how can inflation take off to the upside?

A: Great question. First, inflation has already accelerated higher. Much higher. But you’re right, with the economy slowing, there is likely to be a short-term lull in inflation, with stocks sliding, as they are now, and most commodities pulling back over the next few months.

But don’t be fooled by a slowing economy or any pullbacks in commodities. The long-term trend is for much higher prices. As I noted in past issues, we will not see major inflation until the 2015/16 period.

Q: Bernanke seems to be standing pat and giving no hints of any further money printing. Won’t that be bearish for the economy and inflation?

A: Bernanke is doing exactly what I expected him to do: Play tough, and make it look like he’s willing to withdraw stimulus from the economy.

But here too, do not be fooled. That’s just his interim strategy. Bernanke will come back into the markets with QE3 and more money printing, you can bet on it. He just won’t do it until he’s forced to, by slumping economic data and falling asset prices.

Q: Larry, gold is holding up very well, just a hair off its record highs while silver is still floundering after its crash. Why?

A: That should be no surprise. I’ve warned repeatedly that gold was a much stronger — and safer — precious metal to invest in than silver. Savvy investors hoard gold. They do not hoard silver. They trade it.

Silver’s gains will sometimes outpace gold’s as we saw recently. But so will its declines. Silver is far more volatile and is not a monetary metal, as many would like to believe. Only gold is.

All that, and more, is why I have always maintained that investors should focus on gold rather than silver.

Q: Larry, you nailed the Dow on the head for some time now, calling the 2008/9 crash, then the huge rally, and most recently, the wide, go no-where trading range it’s been in. What do you see next for the broad stock markets?

A: As long as the Dow remains below 12,800 — I am short- and intermediate-term bearish, expecting the Dow to re-test major support levels down at 11,500 and lower, as low as the 9,600 level.

The economy right now cannot support higher stock prices. And with Bernanke trying to play tough on QE3 and any additional money-printing, stocks don’t have much upside potential now.

Longer term, however, when the Fed comes back in with QE3 and more, I expect stock prices in general to reflate again, massively, as we head into the 2015/16 time frame. I expect record new nominal highs in the Dow Industrials, the Nasdaq and the S&P 500 by then.

But don’t buy heavily into the stock markets now. Wait for my signal. The pullback that is unfolding will serve to turn almost everyone very bearish again, and that will be the time to buy. Not now.

Q: Larry, I know you believe the euro currency is going to fail. But lately, even though Europe’s problems seem to be worsening, the euro has been rallying against the dollar. Why?

A: Because most traders and investors around the world are focused on the U.S. debt ceiling, and the potential that it might not be raised in time and that the U.S. Treasury will technically default on its obligations by delaying interest payments come August 2.

So right now, the euro is stronger than the dollar.

However, Congress will raise the debt ceiling. I have no doubts they will. They will wait until the last minute, but they will raise it.

I suspect that once they do, we will find the opposite trend unfold in the short term, the euro start sliding and the dollar stage a bit of a rally.

But no matter what, stick with “real money” for up to 25% of your total investable funds. What’s real money? GOLD!

I also like the Swiss franc, and the Aussie and Canadian dollars. Not to mention the Chinese yuan, and even the Thai baht.

Speaking of the Thai baht, when I moved to Thailand about two years ago, I invested about 30% of my net worth in the currency. And guess what? Those Thai baht are now worth fully 20% more than they were two years ago.

Q: What do you think of the two “Enron-style” collapses that just occurred in China, with Longtop Financial and Sino-Forest blowing up as frauds, costing shareholders billions?

A: China is not immune to fraud. No country or economic system is. But China’s growth story is still very much intact. So is the profit potential. Not only in China, but also in India and other Asian markets.

Q: Why aren’t Treasury bond prices crashing, like you forecast?

A: Rest assured, they will. I suspect the timing of an all-out crash in bond prices will not happen until later this year.

Now, to some strategies I’m using in my own account …

Controlling risk and accepting
losses is everything!

I’m often asked what I think the single most important ingredient to successful investing or trading is. By far and away, the most important factor is controlling risk.

But controlling risk, by itself, is not enough. Being able to psychologically accept losses is also critical.

I’ll explain by way of the system I designed that I use for my own trading.

In rigorous back testing, it turned a $100,000 investment into $1,870,340,272.53, in a 16-year period.

Pretty wild, I know. But that’s after brokerage commissions and accounting for normal slippage in the markets. In other words, getting slightly higher prices when buying, or slightly lower prices when selling positions.

Over that 16-year period, the system executed 1,698 trades. Of those 1,698 trades …

Only 675, or 39.8%, were winners, while …

1,023, or fully 60.2%, were losers!

In other words, nearly two out of every three trades were losers.

It did so by controlling risk tightly, accepting the inevitable losers, and letting the winners run with profits.

More specifically …

The risk on each and every trade was never more than 2.2% of the gross value of the account. If 2.2% was lost, the trade was exited immediately.

On the upside, profitable trades were allowed to run until either the trend changed (as defined by the models systems), or the trade was stopped out using a trailing stop.

In total, over the 16 and half years and 1,698 trades …

The 1,023 losing trades lost $3,977,837.34 per trade, while …

The 675 winners made an average of $8,799,359.81 each.

In other words, winning trades made $2.21 for every $1 loss on losing trades.

But because risk was strictly controlled to 2.2% of equity on each and every trade, the profits on the winning trades — even though they were far less frequent than losing trades — covered the losing trades in aces and spades, to say the least, and could have turned $100,000 into $1.87 BILLION.

Some more stats …

Over the 16 and one-half years of back tested trading, there were only two losing years.

On a monthly basis, 61.6% of the months were winners.

The compounded annual growth rate of the period was a whopping 81.96%.

Bottom line: Is turning $100,000 into more than a billion dollars in 16 years possible without using high leverage? Realistically, probably not, but it does illustrate what could happen when you always tightly control your risk, accept the inevitable losses that come, and let your profits fully bloom.

Best wishes, as always …

Larry

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