Forget Bernanke's Speech, Let's Head To The Races!

Yesterday gold dropped $17.

…on a day when Ben Bernanke promised NOT to hit the brakes on his monthly campaign of easing. (Heck, the man won’t even pump the brakes, just to make sure they still work!) That means more bond buying and long-term low interest rates. It’s a savers nightmare, and underpins our precious metals outlook.

However, metals prices couldn’t stay in the black on the news. Utter nonsense, if you ask me.

With that in mind, let’s head elsewhere for some investable logic: the racetrack!

Today I want to show you how horse racing, and more specifically horse wagering, has a lot more to do with the resource investing market than you’d think.

This past weekend I attended the Preakness Stakes horse race. Held in your editor’s backyard, Baltimore, it’s the second leg to the prestigious Triple Crown.

To be honest, I didn’t even bet a buck on the Stakes race – I was there for the spectacle of it all. And boy is there a lot to be learned…

The Secrets of the Track: Revealed!

Really, there’s no better analogy to investing than horse racing.

For starters, just think about horses as stocks. A smart bet is based on the past performance of a horse, much as any investment would be made on past performance and history of a company. You can also look to the bloodline of a horse to get a feel for what it’s capable of — much as you can look at specific sectors of the market.

The trainers/owners of a horse are much like the CEOs/insiders of a company. Prior to a race or an earnings announcement, these representatives may paint a rosy picture — “my horse is in fine shape” but how much can you really trust them? (Heck, they could even have some skin in the game, for or against their own pony!)

There are also “locals” who know the field. Whether you’re at a horse track or an investment seminar, these experts will have an upper hand over the general public. After all, these insiders study every day, so naturally, they know the specifics — whether it be horses or stocks.

From there, it comes down to the betting itself. Much like a stock price, each horse has odds — these odds are generated by public sentiment.

If the majority of the public’s money is on one horse, that horse is the favorite — this is completely independent of the horse’s credentials. Just like if a majority of the public thinks Enron, Apple or Facebook is a good stock — the stock remains high… until, of course, the gates open and the truth is revealed.

Importantly, though, much like the stock market, in horse racing, your main goal is to beat the public. The public sways the odds of horses much like it sways the valuation of stock prices. And when you get down to it, this is one of the most critical parts of investing, beating the public bet. (Even in picking your favorite resource stock!)

A Method to the Madness

The horse track is nothing more than a clear-cut analogy for the stock market.

So what are the takeaways?

For the answer to that question, I’ll have to go to one of my favorite books, Secrets of Professional Turf Betting by Robert Bacon. I even keep a copy of the book at my desk.

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To be clear, I don’t normally read books about horse racing — I’m not that into it. Indeed, there’s more to this book than meets the eye.

First off, the book is out of print and was first published in the ’50s. The reason that it has some real staying power is that the subject matter directly relates to the financial markets.

Bacon pioneered the sociology of horse betting. And he did so in a way that can be directly related to your investment strategy.

A main thrust in Secrets is that you need to be able to beat the crowd. Here’s how he words it in Chapter 1:

Professionals win because they know the ‘inside’ principle of beating the races, the same principle that must be used to beat any speculative game or business from which a legal “take,” house percentage or brokerage fee is extracted. That principle is: “COPPER THE PUBLIC’S IDEAS AND PLAY AT ALL TIMES!” That is not abstract theory — it is practical percentage, as will be learned in later chapters.

The word “copper” in this sense means “bet against.” So the key to professional winning is to bet against the public. You may have heard this same thing said different ways — “buying when there’s blood in the streets,” “buying the dips” and “contrarian investing” all require you to copper the public.

Another important idea that Bacon brings up is revealed in Chapter 5, “The Principle of Ever-Changing Cycles”:

The would-be professional player must always understand that the form moves away from the public’s knowledge. (Just another principle of beating the races that has never before been explained in print for smart readers!)

As bettors/investors become wise to a certain investment, it will naturally become overvalued — therefore making it a poor bet/investment. At the track, this would be represented by a horse that “should” return you three times your money getting bet down by the public to where it would only return two times your money.

As a recent example, the Preakness Stakes favorite “Orb” was expected to be a 1-to-1 bet – meaning you bet a buck and if he wins you get back two, total. But as the public bought into his story and expectations for a Triple Crown winner ran high, his odds were bet down to 3-to-5 – meaning you bet a buck and if he wins you get back $1.60.

Win or lose, that’s a beaten-down, bad bet.

More importantly, in the case of, say, overvalued shares of Apple at $700, it’s a flawed investment strategy, too.

Continuing on, Bacon also warns of another important pitfall, what he calls the “switches.” The key behind this principle is to stay with what you know… don’t get emotional and switch your bet:

Some amateur players carry inconsistency to such a degree that they demand consistency from the horse, while at the same time being utterly inconsistent in their methods of play. It’s not the races that beat these players — it’s the switches!

For example, say you are at the races all day betting just one horse to win in each race — then, after a losing streak, you “switch” your betting method to something else – you look to more exotic bets or “show” tickets. Bacon portends that this is an amateur’s trap.

The professionals will have a betting method and stick to it — consistency is what helps them win.

This rings true in our investing strategy, as well. Not every stock will be a winner, but you need to develop a system that allows you to profit, nonetheless.

So how does this relate to our resource investments?

First off, we’re lucky because we’re always knee-deep in “local” help. The contributors that we publish are consistently getting their boots muddy in the resource sector — which puts us well ahead of the game. Byron King for example, knows how to evaluate a gold miner or oil company far better than any Tom, Dick or Harry in the public.

Plus, we’re investing in the right bloodline. The resource sector is, and always will be, in high demand – just remember, there are seven billion (and growing) folks on this planet. Whether it’s oil to run a car, natural gas to heat a house, gold to back our world’s currency or even an agricultural angle with fertilizers, we’ve got plenty of profit potential coming our way.

Truly, the current run in resource companies is far from over. But believe it or not, not all investors think that way. There are still plenty of undervalued long-term resource plays — many of which we talk about here. As always, keep your eyes peeled for specific opportunities and feel free to copper the public and buy on the dips.

One last takeaway that’s especially true in today’s market is to avoid the “switches.” Even though gold and silver have taken a beating, of late, it’s not time to switch our logic.

As Ben Bernanke made increasingly clear in yesterday’s announcement, cheap money and government spending are here for the long-haul. As Bernanke’s twisted line of thinking goes: what would the S&P do without my help?!

That’s the same long-term logic that’s bound to push metals higher. The way I see it, the odds are in our favor.

Keep your boots muddy,

Matt Insley

The Daily Reckoning