Editor's note: It's a common misconception.
People often confuse speculating with gambling. The truth is, done right, you can greatly stack the odds in your favor.
To explain this concept in detail, this weekend we're featuring a classic interview with Doug Casey, founder and chairman of our affiliate, Casey Research.
Doug is a master speculator and longtime contrarian investor. He's one of the brightest minds in our business – a New York Times best-selling author who has made a fortune over the years by speculating on commodities, currency, and stock markets.
Today's Masters Series is the first part of an interview that appears in his 2014 book Right on the Money. In it, he explains the difference between investing and speculating... the importance of diversifying... and how to turn a speculation into a 50/50 proposition...
Doug Casey on Winning Speculations, Part I
Louis James: Doug, these conversations are going out to a wider and wider audience – almost 100,000 now. A lot of these readers are new to our style of investing. They've heard of your 30-year track record of picking winning investments, and many are wondering how you do it. Can we tell them the secret?
Doug Casey: Well, it's not really a secret. I have a method for picking resource stocks and other speculations; all our analysts at Casey Research use it. We even have a free report on our website describing this method, called The Eight Ps of Resource Stock Evaluation.
We try hard to educate our subscribers in using this method themselves, and encourage them not to follow our recommendations blindly. Our goal is to educate subscribers in all the important aspects of our business: geology, engineering – all aspects of the markets.
We make a lot of investment recommendations, but we don't just tout stocks – it's not like being a railbird at a racetrack. Each speculator has different amounts of capital available, different tolerance for risk, different areas of interest, and so on. But it's not just about knowledge; it's critical to have a method of some description. And to exercise discipline. But before we get into that, let's talk about speculation itself.
Louis: As distinct from investing.
Doug: Yes. Properly speaking, investing is the act of putting capital into a business in anticipation of making a profit. Sounds easy and simple, but it's not.
The best description of good investment methodology is The Intelligent Investor, Graham and Dodd's seminal work on securities analysis, first published in 1949. The book is still a financial bestseller today, because it's clearly written, very well thought out, and covers all the bases.
I don't just recommend it. I'll go so far as to say it's totally indispensable. If you're not thoroughly familiar with the concepts in the book, you're going into "the battle for investment survival" (another good book, incidentally, by Gerald Loeb) unarmed.
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 [gains greater than] 1,000%.
My ideal is to divide a speculative portfolio into 10 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-to-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.
Louis: 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.
Louis: 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 [more than] 30% into volatile speculations – basically, the one-third 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.
Louis: 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 100-to-1, or even 50-to-1 against. I mean, a one-in-five chance of winning, or 50-50 odds, and even, in some cases, better than a 50% chance of coming out ahead. And when you do win, you can win 100-to-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.
Louis: 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.
Editor's note: Over the years, Doug has made millions of dollars in the markets by speculating wisely. And right now, he's pulling back the curtain on his incredibly successful strategies. Best of all, you can use these strategies with as little as a few thousand dollars and a regular brokerage account. Get the details here.