A Growth Maven's New Favorite: Gold

Interview with Joseph McNay, Chairman, Essex Investment ManagementBy SANDRA WARD

NOT MUCH ESCAPES THE ATTENTION OF THIS wise and wily investor. Near visionary in his ability to identify trends and capitalize on them, Joseph McNay has made a lot of people and institutions wealthy in the 40-plus years he's been plying the investment trade. He manages more than $3 billion at Essex Investment Management in Boston, a firm he founded, including its flagship long-short fund and a natural-resources fund. One of the all-time greats of growth investing, McNay is now pounding the table for, of all things, gold. Attention must be paid.
Barron's: Are we in a recession or are we perhaps talking ourselves into one?

McNay: We certainly are in an economic slowdown, and my personal opinion is that we are in the early phases of a recession.

Whether we are in a recession or not is irrelevant because we are slowing down, and results are becoming more negative. The Federal Reserve has been very much aware of this and has been acting consistently in that regard. They've been increasing the money supply at a much faster rate than people realize, near a 15% annual rate of increase in M3 [a broad measure of the money supply].

What would be more typical growth in M3?

Five percent, maybe. Increasing the money supply kept the situation from getting worse faster than it would have otherwise. From one point of view, that's good. But there is a point of view from which it is not good, and that is it decreases the value of our currency on a consistent basis and sometimes at an accelerated rate. In the past four or five years, the euro has gone from 82 cents to the dollar to $1.48. That is all lost purchasing power in our currency. We are in a lose-lose situation. The decline in the value of our currency is directly inflationary: Lost purchasing power is inflation. The bigger risk is that, at some point, the large holders of U.S. dollars may decide they want a lot less of them, if any. This is a very challenging set of conditions for us.

What does this mean for the market?

We are going to have an even more narrowed and focused market than we had last year. Something the world is going to want now is a currency alternative. An investment I have felt positive about but now feel dramatically more positive about is gold. Gold is probably the single most important investment that most of us can have a representation in.

It has run up quite a bit in the past five years.

Well, it depends on how you look at it. It is back to its old high. But if you compare it with the value of the Dow Jones and the value of the dollar, it's not up nearly as much as one might think. At most tops in gold, gold and the Dow Jones Industrial Average sell at the same price. Right now, gold is about one-fourteenth the price of the Dow. We are denigrating the value of our currency at a much faster rate than we have in the past. The government is running a $250 billion to $400 billion deficit, and our balance of trade is running at a $700 billion or $800 billion deficit. This has all created money at a rate faster than we produce and means that we are further in debt and the value of our money falls faster. One has to come to decisions on how to protect the value of money. Cash is king in the minds of some people. But the biggest question associated with that decision is what currency do you keep your cash in?

And?

I would rather own the Chinese currency than the U.S. currency. As they revalue upwards, it's a growth investment and it gives protection against losing purchasing power, and that is what we are all facing.

When you talk about gold, should people be thinking in terms of the mining companies or bullion?

Both. The metal has outperformed the mining companies in the last three years, but that relationship is in the process of switching and mining companies will be the best investment. But they will both be good investments. There are two ETFs that are convenient for a lot of people: streetTracks Gold Trust [ticker: GLD] tracks the gold and Market Vector Gold Miners [GDX] tracks the mining companies.

What's the outlook for growth stocks in this environment?

People will be attracted to companies that grow. We will have more rounds of the kinds of problems we have already experienced, and it will force people increasingly to focus on investments that do well without regard to the economy. I'm unwilling to buy the financials yet, for instance, because we have Round Two coming shortly. Round Two will be credit-card problems. With people unable to borrow against their residences as they did previously, they simply have increased their credit-card debt. That will start to show up as loan quality deteriorates and that will be seeping through our system.

What areas are you focused on?

The whole medical-pharmaceutical-biotechnology area. Demand for these products is absolutely off the wall.

Can you be more specific?

The biotech companies have the new products and are a way to participate in this industry. They are like buying the drug companies back in 1960. My three favorites are Genentech [DNA] and Gilead Sciences [GILD] and Celgene [CELG]. They all have very good products and great growth rates, and no risk, from my point of view, to an economic slowdown and a falling dollar.
How about a new recommendation in that area?
BioMarin Pharmaceuticals [BMRN] has some nice products. It is coming along with some very nice drugs to treat small patient populations, similar to Genzyme [GENZ], where there is not much competition and the drug has a limited market but is necessary for survival.

What do you like among medical-device and instrument companies?

I love Intuitive Surgical [ISRG], the leader in robotic surgery. It went up a lot, from about 105 to 350, before falling back to 254, and so it has corrected. But it has the absolute leadership position in the field and is continuing to grow very rapidly. If you have breast cancer or prostate cancer or are having a hysterectomy, you unequivocally want to go where they are using Intuitive Surgical robotic surgery because the results are much better. That's a good growth area. The stock is still kind of rich, even though it has corrected, but it has a lot of growth ahead of it.

Let's turn to some emerging companies that have caught your interest.

A company called Aladdin Knowledge Systems [ALDN] has been overlooked by a lot of people. It is an Israeli company that develops enterprise-network security software used for application access. This company has been growing earnings at 20%-plus lately. Last year, earnings rose from 93 cents a share to $1.15, and this year they are probably going to go to $1.40 a share. They had a very good quarter recently, up over 21%. It's not too expensive, selling at 20 and earning, say, $1.40 a share this year and $1.60 next year.

Or there's Perrigo [PRGO], which takes drugs that go off patent and then makes a private-label product for drugstores to sell. It is getting terrific reception from drugstores. This company is just starting to accelerate with a number of new drugs like analgesics and vitamins and nutrition and gastrointestinal treatments. Its earnings in the last quarter were up 89%, largely because of good profit-margin improvements. The quarter before that earnings were up 26%, and that's coming off of a long, flat period. It should earn about $1.45 this year and probably $1.80 next year. The stock is around 31.

Anything else along these lines?

I would throw in a company called Vasco Data Security International [VDSI]. Here is a company with a real growth rate. It has been growing at over 60% a quarter in the last three or four quarters. Its sales are up 44%, 93%, 75% and 60% in the past four quarters. It makes software- security systems that manage access to information. Only 7% of its business is in the U.S. This is a company growing every quarter between 40% and 75%. It did 33 cents last year and will do probably 65 or 70 cents this year -- a double. Next year it should earn about 90 cents. You can buy it at 19 a share, down from 45.

Any other dynamos you want to share?

U.S. Geothermal [GTH.Canada] is one that is just in the process of coming on strong. Its geothermal capability is all over the far western U.S., where they supply energy to utilities. It is the No. 1 company in the U.S. in this area. But it has just started to produce revenue. It is based in Vancouver, British Columbia. It is truly outstanding from the standpoint of not being well known and yet being No. 1 in the industry in North America and just becoming profitable. It is benefiting from the cost of energy going up and the search for alternatives.
It is a tiny stock.

It is just starting. They are going into new states. They will go into Oregon, then New Mexico. This will be their first year with revenue. That will grow very rapidly and it will increase 75% to 100% later this year and into next year. This is a real come-on stock that a lot of people are not familiar with.

It trades only 113,000 shares a day. Do you expect them to be issuing new shares?
I am certain that they will raise money, certainly this year. You can look upon it as either dilutive or let's say the stock bounced from 2 to 4, it would be the opposite of dilutive.

Any other sectors you want to talk about?

Another area that is significant and that we must pay some attention to is agriculture, because worldwide demand for food is going up. The companies that are large and well known, like Archer Daniels Midland [ADM] or Monsanto [MON] or Bunge [BG] or Potash Corporation of Saskatchewan [POT] or John Deere [DE] in the equipment area, are all doing very well. But one stock that hasn't gotten as much attention as it might is DuPont [DD]. It doesn't have a high growth rate -- revenues are in the 6% range -- but it is selling at about 13 times earnings, and coming on with a seed business to compete with Monsanto.
Still, the caveat here is that you are recommending these stocks in the context of a rather bearish overall outlook.

It is a very difficult environment and we have the most stretched financial system that has occurred since I have been in the business, not to mention probably alive. The extension of debt not only represented by subprime loans and credit cards, but also by the government running big deficits and our population buying more than we produce and creating money to do it -- this is an entrenched long-term problem of significance and the implications are bigger than anything
I believe we have seen.

We are at a point where there has been enough building of short interest and liquidation of stocks that we could have a rally. However, that will be a rally in what will be a market that continues to deteriorate.

One must be very sensitive and look upon it as a bounce, not the start of a bull market. We haven't seen the height of the mortgage-market problems yet. The first six months of this year will be the biggest unwinding of adjustable-rate mortgages that we have had, and that will start to impact.

Of course, the government is going to come out with a series of stimulus packages, and that may get people excited and make them feel more comfortable. And, of course, interest rates have come down and all of those things will give people an excuse to go in and buy. But be careful, focus and look out.
Thanks, Joe.