Doug Casey on Winning Speculations - December 16, 2009
Published: December 16, 2009 by GoldSpeculator
But the truth is that I don't consider myself an investor. I'm a speculator. Which is to say someone who allocates capital in order to profit from distortions in the market caused by government intervention. The definition I just gave is the proper one for speculation - but the word is also used to describe investing in high-risk things, which may be totally different. It's a source of great confusion, often leading to disaster, when people use words inaccurately, and often without actually even knowing what they mean. Anyway, the times ahead of us are going to be tough on prudent investors, but a boon for speculators.
I've long said that it makes no sense to risk 100% of your wealth on "conservative" investments that might give you a 10% return - if you're lucky. There are a lot more GMs and Fannie Maes out there, I promise you. To me it makes more sense to allocate 10% of your portfolio to speculations that can yield +1,000% gains. My ideal is to divide a speculative portfolio into ten unrelated areas, each of which (in your subjective opinion, because certainty only exists in the minds of fools, bureaucrats, and ideologues) has at least a 50-50 chance of winning, with the potential for a 10-1 win.
Especially in volatile times with inflation written on the wall, you can't afford to sit on cash or supposedly "safe" investments - you need a portion of your portfolio invested in speculations that can double in a year, or pull much higher multiples if their ships come in.
L: We talked about this a bit in our conversation on gold stocks, but even then you said that diversifying speculation into other areas improved the odds of success. The same reasoning applies.
Doug: Right. I believe in diversification, but not into just everything in general - like a lot of mutual funds. The problem is that it's very hard to find many really appealing speculations, although I do like cattle and some other rather obscure things. It's a good reason to read about everything, everywhere, because it might better attune you to an opportunity very few others might see. That is where life-changing amounts of money can be made.
L: In these highly volatile times, in which many "safe" investments are proving to be not so safe, might you increase your normal 10% guidance?
Doug: Sure, 20% might make sense for the people who can tolerate the exposure to higher risk. But, as you say, the conventional "safe" stuff is at higher risk as well. It's a question of do as I say, not as I do, however, because I'm a lot higher than 20% - although most of my money is still in physical gold, silver, and unleveraged real estate in the right places. Here a distinction must be made between volatility and risk. Risk is something you should always minimize, especially right now, with the Greater Depression just getting started.
Unfortunately, most people don't understand systemic risk and believe the government can shield them from it. And they're afraid of volatility, although volatility can be your best friend. Now is a great time to put that friend to work for you, as we do in our energy, metals and technology letters. If you can afford to sustain some hefty losses and rebuild your portfolio, should you be dealt a losing hand, you might go as high as putting +30% into volatile speculations - basically the 1/3 of our general portfolio recommendation that we suggest for stocks (the other thirds being gold and cash). But be careful about making "all in" bets. You can't be an effective capitalist without capital.
L: I know you play a lot of poker, so the gambling metaphor comes easily to mind, but I've also heard you say many times that speculation, done properly, is not gambling. Can you explain that?
Doug: Yes, there's a huge difference. Gambling relies strictly on dumb luck - will red or black come up next on the roulette wheel. Of course there's an element of luck in both investing and speculation, just as in life itself. But it's mitigated and controlled. You can apply your intelligence and effort researching a speculation, greatly improving your odds over random chance. Throwing darts at a list of stocks, even gold stocks, would be gambling. Researching companies and applying the Eight Ps changes it from a game of pure chance. Of course poker is neither investing nor speculation - it's gambling, but a very sophisticated form that relies heavily on math and psychology. It takes intelligence to play poker well.
Another thing is taking a step back, looking at the big picture, and correctly identifying trends that have clear implications for you as a speculator. For example, when everything you see, read, and hear convinces you that major inflation is on the way - which I believe is so - then there are clear implications for speculators, such as rising gold prices (and gold stocks, even more so) and rising interest rates. And while it won't do so equally, a rising tide does tend to raise all ships - at least the ones with no holes in their hulls.
That means you can stack the odds greatly in your favor - and I don't just mean reducing thousands-to-one against, as in a lottery, to a hundred-to-one, or even fifty-to-one against. I mean, a one-in-five chance of winning, or fifty-fifty odds, and even, in some cases, better than a 50 percent chance of coming out ahead. And when you do win, you can win 100-1, which makes up for lots of little losses.
This is why we put so much effort into The Casey Report, our big-picture newsletter. It's essential for us to keep the big picture in mind when we review possible speculations, to keep the odds skewed in our favor.
L: Can a high-stakes speculation really have better-than-even odds of winning?
Doug: It'd be senseless to try to put specific odds on a stock pick, of course, but when you spot an undervalued story with real merit, there are times when something truly unexpected and disastrously bad would have to happen to the company, or the market itself would have to turn against your expectation, to keep the stock from rising.
And if you can buy into a private placement, you can usually get warrants that offer you an option to profit from success without having to pony up the cash until you know you'll make money exercising.
L: Ah, the power of private placements, but let's come back to that. First, let's have a quick look at the Eight Ps, for those not familiar with them.
Doug: Okay, but I do recommend that report, even to those who have little appetite for speculation. It's not that long and has a lot of my 30-plus years of experience as a speculator boiled down into it. The Ps are usable for all stocks, but are especially valuable for companies that don't have significant assets and have no history of earnings - probably not even any sales. Graham/Dodd analysis simply doesn't apply to such companies. But that doesn't mean they can't be excellent speculations.
So, the first P is People. No matter how great the rest of the Ps might be, if you don't have confidence in the people, you can't have confidence in the rest of the story. There's no shortage of crooks, incompetents, and just plain stupid people in the resource sector we concentrate on, but that's equally true of real estate, tech, and any other business. Actually, it's possible to make money on crooks, incompetents, and even stupid people, but you have to get the timing right (buy in early and sell before the deal goes sour), and that's exceptionally risky - and, remember, I like volatility but not risk.
In general, I stick with people I know have the skills, determination, and track record of success it takes to beat the odds and deliver huge amounts of added value. If I don't know the people involved, I usually know someone who does, or you or Marin know them. I also like to see management sharing the same risk and therefore having incentives aligned with shareholders - and I don't mean freebie stock options. I mean they put their own money into the deal and have a substantial stake in adding shareholder value.
If I'm not satisfied with the first P, it's usually not worth looking at the rest. There aren't enough hours in the day...
Doug: Well, I said you could make money on crooks, and we made something over 5,000% gains on Bre-X - but I didn't know it was a scam at the time. Nobody did. We got in early on a great story and sold when we had a huge win and it started sounding too good to be true - about when its market cap exceeded that of Freeport McMoRan. That sell turned out to be slightly early, but that was much better than being late, because it went to zero.
Diamond Fields' was a completely accidental discovery of the massive Voisey's Bay base metal deposit in Labrador, when they were about to bail and concentrate on offshore diamonds in Namibia. The psychotic break was on the part of a broker friend of mine in Chicago, now deceased, who personally drove the share price of Nevsun through the roof by sheer willpower.
These were all penny stocks that went well above $100 a share in the first two instances, and $20 in the third. Happy anomalies like these are part of why I have solipsistic tendencies...
But you can never know those things are coming - there's no speculation strategy for increasing your odds of having one of these in your portfolio, other than the general strategy of being in the resource sector, where it's actually possible to make 50 times your initial investment in a couple years. Resource stocks are, by far, the most volatile class of securities on the planet.
L: And backing the best in the business does improve your odds. Got it. What's next?
Doug: After People, the Ps don't really have a fixed order, but the next most crucial ones are Property, Paper, and Phinancing.
Property is pretty obvious: whether it's an oil field, a mineral exploration project, a tech deal, or a real estate development, the project should be of genuine merit - that's why I ask you to go all around the world to check up on these things. Even with the best of people involved, we want to make our own judgments on the merits of the properties in question.
Paper refers to a company's share structure; you want to watch out, for instance, for large numbers of restricted shares that might come free trading soon - they can put a lot of selling pressure on a company if they're in the money, especially if their owners have warrants. More on that in a minute. A relatively large number of shares selling at low prices is also usually a sign of a checkered past. But on the other hand, too tight a share structure can be problematical as well, because there's not enough trading volume to make it possible to buy or sell at good prices.
Phinancing (apologies to any language purists out there - the rest all start with P) refers to the cash on hand, compared to the cash needed to achieve the next milestones. When credit is tight and financing hard to come by, there's just no sense in buying shares in a company that's low on cash. Even if they have great property being advanced by the best people, you know they are going to have to finance soon, which usually means you can get in at a cheaper price if you exercise a little patience (either because you can buy into the private placement or because the placement causes the share price to drop, as often happens). And if they don't finance, they won't have the wherewithal to add value, so either way, I rarely buy companies that are low on cash, unless it's on the back of an attractive financing.
L: Roger that - and the rest of the Ps?
Doug: They are Politics, Promotion, Push, and Price.
Politics refers to the risk of political intervention (or "social" problems, which amount to the same thing) that can ruin a perfectly good project. Anything from trouble with indigenous populations, to local bans on your company's proposed activity, to raised taxes and royalties, to new regulations that ruin a project's economics - there's so much economically suicidal politics that can kill a deal, it could take years to list all the specific risks. But these things really have killed, are killing, and will kill projects, so you have to research local, regional, and national politics carefully and avoid speculations with clear political red flags. Or use them to your advantage when you think others are reading things wrong.
Promotion refers to a company's ability to get its story out to the market. I've lost money on good people working on great projects because they simply could not promote their work to a market that would have cared had it known about it. "Promotional" has negative connotations - but that's only justified when a company has nothing but promotion going for it. All sizzle and no bacon. If your pick really does have the bacon, it's essential that it be effective at getting the market to hear the sizzle.
Push is related to Promotion but is not the same thing. It's the specific set of milestones that you can reasonably expect to push share prices higher. This could be a value-accretive acquisition, important drill results from a mineral or oil/gas play, a feasibility study - basically any good news you have reason to believe lies ahead and should be good for the share price. A catalyzing event that makes the deal a "buy" right now, as opposed to at some unknown time in the future.
Price is not simply the share price, nor just a company's market capitalization (share price times number of shares issued and outstanding), but those things in relation to the price of the underlying commodity or asset a company was working on. In other words: Is the price of gold, oil, uranium, copper, nickel, lithium, or whatever - a hundred other commodities - going up or down? You've got to have a grip on the big picture of the world economy, as well as the technologies that are using, will be using, or may stop using these things.
L: These Eight Ps have become my Eight Commandments, and they sure have worked for me. So, I think our astute readers can see how private placements fit into this, but can you spell that out for us in brief as well?
Doug: Sure. When a company needs cash, it usually either borrows it (bonds, debentures, and lines of credit) or issues more stock. There are other options, like selling royalties or doing JVs, of course. For going concerns, it's usually debt, but if a bank won't lend the company money, it's usually forced to dilute existing shareholders by issuing new paper. That's generally a bad sign in a company that has cash flow. But in the junior exploration companies, both in oil and gas where Marin concentrates and in metals where you concentrate, there is almost never any significant revenue, so they are constantly back at the trough, raising more money - and that's a good thing if they add value burning that cash.
L: As when a company spends $50 million exploring and developing a gold project that ends up with a $500 million NPV.
Doug: Speak to me... If it's a good company, meaning, solid on the Eight Ps except for needing more cash, a financing via a private placement of new shares to existing and new shareholders can be a great opportunity.
L: A lot of people seem reluctant to go there. There are trading holds placed on the new shares, hassles getting brokers to cooperate, and qualification requirements. Can you tell us why all of this is worth the effort?
Doug: Leverage. Think about it, why would anyone buy new shares in a public company when they can just buy shares on the open market? Because the company offers them incentives, usually in the form of selling the new shares at a significant discount to market, and/or offering a warrant - a kind of free option to buy more shares in the future at a set price.
The warrants, in particular, are very powerful. Listen, if you like a company enough to buy the shares anyway, and you can do so at or under market and get a free warrant as well, it's a no-brainer. When the shares come free trading, which is only after four months in Canada, where most of our stocks trade, you can sell them and retain upside free of risk through the warrants, or you can hold them, in which case the warrants multiply your potential upside.
If a warrant is good, say, for two years, that gives the company a long time to add value, and you only exercise the warrant if you can sell the shares you'd get for more than what you'd pay for them. You either know you're going to win, or you don't spend another dime.
L: Okay, but what about the hassles?
Doug: They exist, and they can be quite onerous. Many private placements offered by Canadian companies are not available to "U.S. Persons" and even when they are, you generally need to be a qualified investor, which, among other things, usually means having a net worth in excess of a million dollars.
But if you qualify, you're walking away from free money if you don't participate in private placements, and a good broker can help you handle the hassles.
L: And if any readers don't qualify, I'd be happy to help them build their portfolio value to the point at which they do qualify, as would Marin.
Doug: And you both do a fine job at it.
L: Aww... C'mon, you're making me blush.
Doug: Well then, we'll try to talk about something that has nothing to do with you next week.
L: I look forward to it.
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