This Kind of Opportunity Only Comes 'Once or Twice a Generation'

Editor's note: Speculation and investing are very different.

And nobody we know is better at speculating than our good friend Doug Casey, chairman and founder of Casey Research. Doug has spent the last 40 years actively speculating in the markets.

In today's edition of our weekend Masters Series – an edited excerpt from a recent conversation between Porter and Doug – they discuss the best opportunities for speculation... where we are in the current bubble... and why the speculation Porter has been preparing for is so rare...

This Kind of Opportunity Only Comes 'Once or Twice a Generation'
An interview with Doug Casey, chairman, Casey Research

Porter Stansberry: Doug, thank you very much for joining us today. Can we start with just a definition: What does speculation mean and how is it different than investing?

Doug Casey: People often conflate and confuse the two concepts, but they're very different.

An investor will put a dollar some place in order to make real wealth grow. It's like planting a seed of corn, hoping to get a whole stalk of corn with hundreds of new seeds. That's what investing is all about. It's generally a long-term process.

Speculation is different. It's capitalizing on politically caused distortions in the marketplace. An ideal speculation is one where the government does something stupid, the results are predictable, and you position yourself to take advantage of the unwinding of what they do.

They're quite different, but people confuse them.

Porter: I think an example is always helpful. Can you talk about your career as a speculator and give me an example of the largest opportunities as a speculator that you've seen in your career?

Doug: The biggest one in our lifetime was gold, which was controlled in price at $35 an ounce from 1933 to 1971. President Nixon took the dollar off of the gold standard, and over the next decade, it went from $35 an ounce to a high of $850 an ounce in 1980. That's the classic speculation.

Porter: Let's talk about that. In 1933, the government seized all the privately held gold bullion in the United States... And it began to mandate what the price of gold would be.

Doug, you probably know the details better than I do, but the price of gold was set at $35 an ounce and held there for decades until 1971. By instituting a price control, by artificially limiting the price of gold, that led to a reduction in gold supply... and of course, a much higher, actual fair market price for gold as a result.

When the price controls were taken off in 1971, the price of gold skyrocketed above $800 an ounce as everybody would remember from the 1970s and early 1980s.

The thing I've noticed about situations like this is, when the government artificially controls the price of something, supplies dwindle. And when supplies dwindle enough, there will be a black market and the real price will be there. Sooner or later, the government will have to allow the commodity to trade or else the supplies will continue to dwindle and the black market price will go even higher and higher.

When the inverse occurs, when the government is artificially propping up the price of something by creating new currency dollars to support it, what you'll see instead is the opposite.

The price of the thing being so inflated will lead to an increasing amount of supply – and higher and higher prices.

If you look at the bond markets today, you see that exact scenario has unfolded. The government began to artificially manipulate interest rates lower in 2009 and 2010, and has done so on a greater and greater scale ever since.

Not just the U.S. government, but all the major central banks... to the point where I believe now, the Central Bank in Switzerland has purchased $85,000 in securities, stocks, and bonds for every resident of Switzerland. So as the price of those stocks, bonds, and financial assets hasn't been inflated, obviously the supply has increased.

You see a record amount of corporate-debt issuance, not just in the United States, but around the world as well. The government has created higher prices and there has been an enormous boom in the supply as a result. But all of a sudden, there's a huge disconnect between the price of the thing, which is the bond or the stock, and the income that supports that price.

So you see that the enterprise value of U.S. equities is trading at a higher multiple of earnings than it ever has before. You see that corporate bonds in the United States have issued more debt relative to GDP than they've ever issued before.

Of course, their earnings have been falling now for five quarters in a row – and it could easily be six quarters in a row by the end of this quarter. Incomes are falling, prices are still rising, and supply is booming.

It's only a matter of time until this bubble hits a pin. Doug, I know you agree with me about this and I know you've looked at my work, "The Dirty Thirty" that I've assembled, which is the companies that have the most amount of equity value and also the weakest amount of footing when it comes to repaying their credits.

As a speculator, where do you think we are in the timing of this process and how can people profit from this information?

Doug Casey: The timing is absolutely critical because just because something is inevitable doesn't mean that it's imminent, of course. But I think your timing is excellent right now in going short both stocks and bonds.

Good speculations don't occur every day. They don't occur every week, every month, not even every year. So you've got to be like a crocodile... waiting – perhaps for months, perhaps for a year – before the correct prey comes by.

But this is a fantastic time to short both stocks and bonds. I think the economy itself is on the edge of a precipice at this point. So I'm enthusiastically short at the moment.

Porter: I love the idea of using the government's bubble to position yourself as a speculator.

You know that the government has artificially manipulated the prices of bonds to an unbelievably high point... to where some bonds are trading with a negative yield to maturity. In other words, the price is so high that there is no way that an investor can make money by buying them.

That has never happened before in the history of capitalism. That's the size and scope of this bubble. It's the largest one that I think has ever been created. And there are some ramifications in the markets because of this manipulation, particularly with bond prices.

You've seen that corporations have issued more debt than ever before. You've seen that more companies with lower credit ratings have been able to issue more debt than ever before, so there's a greater amount of "junk" bonds out there than ever before. And you've seen that people who are not credit worthy are able to get credit... For example, most notably, in the subprime auto-lending market.

All of these things play a role in one particular company... Ford Motor.

Ford did not declare bankruptcy back in 2008 when General Motors and Chrysler did. As a result, it still carries $130 billion of debt on its books. Meanwhile, even during the biggest boom in auto sales in history – again, financed mostly with subprime auto credit – Ford hasn't been able to earn enough of a profit to pay for its costs of capital.

You have a situation here that shouldn't exist in a free market. You have a company whose bonds have been inflated by the government's money selling a product where demand has been inflated by the government's money.

And as that unwinds, it'll unwind for a very simple reason... Ford can't afford the debt that it has. Now auto sales are falling and it's because the subprime lending engine put it out last year as subprime auto defaults started rising. Again, it's because the ratio between the income and the price of these financial assets has become so wildly disconnected because of the government's manipulation.

In the situation with Ford, we know that they're closing down their plants because they've had to shut down their subprime-lending activities, so there's not enough demand for their cars.

Meanwhile, we also know that 50% of their bonds will come due in the next five years. That's 50% of $130 billion. We know that there's no way outside of government manipulation that these bonds could be financed... And they can't be financed if their bonds are in default.

This is a great situation. And there's one more aspect of this... You can buy put options on Ford's equity that will go way up in price if Ford defaults on its debts. The prices of those put options are actually trading at record lows because one of the side effects of all the liquidity that the government has produced is that volatility in the stock market has collapsed.

And of course, as you probably know, puts are priced primarily off of volatility. So there's this incredibly ripe situation where Ford's bonds have been inflated, the demand for Ford's cars has been inflated, and the pricing on Ford's put options has been artificially limited all by the same actions of the government. And we know that those actions will be unwound because defaults have started increasing, especially in subprime lending and subprime auto loans.

This is a fantastic case study in how you can use our research and how you can make money as a speculator.

Doug, you've done a lot of speculating over 40 years of your career. How serious are you taking the work that I've done? Are you going to be buying these kinds of speculations with your own capital?

Doug: Absolutely, Porter. This is a rare opportunity that we're being presented with right now. Of course, what you're talking about, buying distant-in-time, out-of-the-money put options, is generally considered a very risky strategy.

But my approach to this is that it's better to risk 10% of your capital for a 100% or 1,000% return than to risk 100% of your capital for a 1% return, which is exactly what most people are doing today.

The opportunity that we see in the market right now is something that only comes up once or twice a generation. I think that the way you're going to exploit it... your timing is great, you've got the macroeconomic wind in your sails, and your choice of companies is ideal.

To answer the question... Yes, I'm going to jump in this with both feet. I consider it not only extremely high potential, but right now – and this will be shocking – I consider it to be low risk, believe it or not.

Porter: I definitely agree with you. I think a diversified portfolio of these speculations is far more likely to lead to substantial capital gains over the next five years than any equity portfolio you could assemble.

It's a very unusual situation where these kinds of speculations can become low risk, but given the trifecta of the impact of the government's manipulation, I believe that's the case.

Doug, thank you for your time today and your expertise. I look forward to seeing you soon.

Doug: Absolutely, Porter. Thank you.

Editor's note: Porter is about to recommend a speculation that promises to be the most profitable one of his career. If he's wrong, you'll lose a little money. But if he's right, you could make 10 or 20 times your money. He'll explain all the details and walk you through it step by step in a FREE live event on Wednesday. Reserve your spot here.