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Investing for Deflation: Reader Asks the Question of the Decade!

Last week, I got an interesting email from a reader:

Hi J.D. This is my first email to you. I would like to let you know that I am very impressed with your technical analysis which goes in details yet you keep it simple.

Thank you, I like to keep it real simple. I'm looking for the simple trades, and don't want to make it overly complicated. There's always, always going to be plenty of other trading opportunities to make money, so I'd prefer to wait for what I like and not get overly complicated. That's just a natural part of my trading style.

May I ask you a few questions?

1. When you provide the list of candidates, is there a way you can give the entry point or a range for the entry point?

That's a great question, and many trading services provide this kind data. And many traders have that as part of their trading regiment. Sometimes, I have conceptual ideas, like prior lows or highs, or gaps in price, moving averages, or retracement areas, which is usually on my charts.

However, most of the time, what I'm watching is the greater market for direction, and then the intraday chart on the market and the individual trading opportunity. I really don't use specific entry points all that much, as I like to watch and use price structure and go from there.

2. I read with interest your article on GLD yesterday but did not know/expect you were going to trade GLL. How could I find this out beforehand?

That is another great question. Honestly, I didn't expect to make that trade when I wrote The Gold Market Trend Review: The Bull Bear Debate. There was no ability to get GLL on my list of things I was watching. I wrote the gold bull bear debate last Wednesday. It wasn't even a trading idea in my brain until Thursday while at the office watching GLD roll over. When GLD broke down Thursday, I thought there might be a trade in this on the bearish direction, and went looking for an ETF. I had never traded an inverse gold ETF before, so I didn't even know what symbol to trade until Thursday.

This was a trade where there was very little time between recognizing the pattern in gold, the price break down, and then the trade. Sometimes, it's trading on the fly intraday. If I were running a paid for service as my full time job I could put out intraday alerts, but my regular job wouldn't provide the time to do that at all. Maybe someday, sounds like fun.

That being said, if the technical analysis is good and I'm correct, we have further downside in GLD, and there is plenty of time to trade GLL, it's just getting started.

3. What software tool do you use to come up with the list of candidates?

You're going to laugh, but I'm old school. In my brokerage account there's a software feature where I can create lists of all the symbols I want to follow. I list 20-70 stocks for several industries, and maybe have 500 stocks in total. It gives me live pricing data for each stock. From there, I manually chart one stock at a time within an industry. It's hilarious, but I like to do it manually. It keeps me far more engaged. I also feel it provides a better sense of the market pulse.

I read a lot of people who like to call market tops on every new high. And by looking at so many individual stocks I have a gauge to market health. If someone believes the market has reached a top, then we should see stocks with topping or exhaustion patterns. If not, then I would be very concerned about the topping call. I find this to be very useful, and yes, time consuming.

4. You obviously trade on technical, how about fundamental?

I personally love this question. The short answer is no. I can't tell you how many times I've traded something and had no clue what the company did or if they made money. I usually find out because of curiosity after the trade is over.

I'd like to provide an example of my all time best trade and how it played out:

Dendreon Corp Chart

Back in early 2007, I was scrolling through my list of small biotech companies, which is something I love to do. I came across DNDN, and what I saw was a little wedge pattern. I widened the time frame to see price from prior to the low in 2020. It looked like a Wave A up, and the Elliott Wave Wedge pattern finished Wave B. The clue was the over lapping price behavior down from the top of A.

This is where it got really interesting. Since wave A and B seemed finished, I was excited to trade what looked to be a Wave C. On a Tuesday morning, we bought a small stake at $3.15 and it closed that day around $3.50. That night I thought since we were squarely in the money and the wedge pattern looked good, I planned to double my position. We did so around $3.65 the very next day (Wednesday). The stock closed that day around $4.

Obviously at this point I was very excited because it's rarely this good, and the timing was impeccable. All night, I kept thinking Thursday morning I was going to back the truck up and fill out a full position. Unfortunately, the stock was closed Thursday for news pending. To say that was nerve racking was an understatement. Friday morning the stock opened and traded between $12-18 if memory serves me correctly, on news a drug of theirs had a favorable test result.

Since I already knew this was a small biotech company, I quickly sold our position, because they often pop on such news and then fade as investors realize it's still years away from final drug approval or making money.

Note: I do not enter trades with this kind of price performance expectation. They are rare. It does illustrate the manual review of stocks on a regular basis, combined with trading a solid pattern (Elliott Wave Wedge) with risk management.

In 1990, I bought and held stocks like ABT, C, XOM, and PEP for many years because I thought we would be in a secular bull market, and those stocks had consistent profit and dividend growth. They were solid investments to hold during the 1990s.

But what I've come to realize is a couple things about fundamentals:

By the time I know a piece of financial data on a company, you can bet insiders, Wall Streeters, and major investors already know that data and it's already priced into the stock. I can't compete with that.

Second, if you take a look at WMT for the past several years, you'll notice a company that has traded sideways, which is dead money, and I think we can all agree that WMT is a fundamentally strong company. Fundamentals don't tell us when to buy, but what.

Most important, I think trading is going to work much better than buy and hold in a secular bear market. If that is the case, technical analysis is what I want to use for trading. It's my opinion that technical analysis tells me what to buy or short, and when.

Technical analysis leads the fundamentals. If I'm using good technical analysis, the fundamental story is wrapped into the price pattern and should provide the appropriate trade long before we learn of the fundamental data and it's too late.

Lastly, since I started trading for my parents back in 2003, we've made money on more than 80% of our trades, and I just don't if I can improve on that figure.

5. Should we enter a severe deflation/depression, how do you plan to manage the money? Would you simply stay in cash for example or continue to short stocks?

This might be the question of the year, maybe decade. As I manage my parent's wealth, we've been running a deflationary investment model since 2003 and continue to do so. Personally, I think we are already in a deflationary period. It's just being masked by government intervention and spin. Whether the stock market high in April 2010 is the high or not, is totally irrelevant in the context of a deflationary cycle.

Trading for my parents is a small part of their wealth management because I believe the following is the most important:

If you have wealth now, your wealth will explode in the future not by growing it, but by keeping it while all most everyone else loses theirs. We've already seen this happen the past few years. That's a sad thought, but the majority of people aren't going to believe we are already in deflation until we hit bottom and they are broke. That's just human nature. When I told family, friends and clients in 2003-2005 to unload real estate and buy gold, they all thought I was institutionally crazy.

Under our deflationary model there's a concept I keep preaching: Get as much money out of the financial system as possible. At the bottom of deflation, when the biggest deals on stocks and real estate are available, you won't be able to go to the bank, broker, or insurance company and get all of your money out. The system will be so broken, the bank will have to ration deposits to clients. This doesn't even consider the risk that you might actually lose money inside the financial system. Thought: How many insurance annuities have used investor money to make commercial real estate loans? We have no idea the risk in annuity portfolios, because they are not regulated like banks.

We have and are continually moving money outside of the financial system. First, I have recommended they own a modestly (very modest) valued home free and clear, with no debt. No debt means you actually own it with no ties to a lender, and that's wealth outside of the financial system. Obviously, the physical ownership of gold and silver bars is a part of this strategy. We also house our metals in a vault off-site, and that's money outside the financial system.

We also believe in short term treasuries. We are actively looking to open an account with Treasury Direct, as a way of owning some treasuries outside of the financial system. We will probably stagger our maturities in a laddered portfolio.

Lastly, and the most interesting part of our deflationary bunker is the use or ownership of Mattress Money. It's not really money stored in a mattress, I just like that term. We have money vaulted off-site, which is also money outside the system.

Currently, we look to add to our Treasury position and our Mattress Money, and decrease funds held inside the bank, broker, and insurance company. We have already eliminated funds held at insurance companies. We now seek to reduce bank and brokerage balance.

The reader asks some great trading questions, but the deflationary investment question is an "all world question" if you believe deflation is here or coming. You have to make the moves now, as you will not be able to at the bottom. Above is our model that I hope that is insightful or useful.

Hope all is well.


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