Alex Green: Why Gold Does Not Have a 'Fair Value'

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Alex isn’t your usual gold bug. Although he believes in owning gold as insurance he says there’s no way to tell whether it’s cheap or expensive at any particular time. He also believes the macro-economic outlook isn’t as gloomy as many think.

Following up on our last interview I talked to Alex while he was in Charlottesville Virginia.

Many of you may wonder why we’re featuring Alex’s comments since he’s more gung-ho about US stocks than we have been recently. As the S&P continues to march higher the rally in US stocks is our ‘elephant in the room.’ We can’t just ignore it. Many investors like Alex believe you’d be crazy to sit out a potentially big rally in the S&P and Dow Jones.

You are likely hearing this viewpoint already from various sources. In my opinion the bullish view on US stocks doesn’t adequately explain why wages and household incomes for most of the US population are stagnant or falling.

Though he’s bullish on the stock market Alex concedes that gold can be a hedge against disaster. He just doesn’t believe that a disaster greater than some temporary turbulence is very likely.

Alex you’ve said to never believe ‘market oracles’ who claim that a particular asset is about to rise or that the market is going to crash. Yet you tell your readers to stick with stocks – why are you confident in the outlook for US stocks

Well when I say to not believe people who are saying “the market’s about to go up” or “about to go down” I’m talking about people who are looking out days weeks months or even a few years. Over the long term stocks definitely go up because sales earnings and profits go up. Share prices follow earnings so it’s a pretty safe bet that the market’s going to go up in the long term. What the market is going to do week-to-week or month-to-month is anyone’s guess.

The reason I see a favorable tailwind for stocks right now is simply that we have an environment with very low inflation rock-bottom interest rates and a dollar which has hit a five-year high against the euro and a seven-year high against the yen. We have a strengthening currency and an energy renaissance where we have so much oil and gas that the price is plunging. That’s good for utilities good for transporters and good for manufacturing companies. It has all kinds of positive implications for businesses and consumers who save money on their heating bills and at the pump. They’re now going to spend that money elsewhere – and that’s favorable too.

We have record high and rising corporate earnings and record profit margins. You just have so many positive things happening that while people tend to dwell on the short-term negatives – and there are plenty of those too – there’s a very positive backdrop to stocks overall. I’d be the first to say however that the market can always trip you up or surprise you in the short term no matter how good the outlook.

So if I understand your investment thesis correctly businesses get better and better with time which causes shareholder returns to rise steadily. Over time you expect businesses to improve on average. Do you try to distinguish between good businesses and bad businesses

That’s really all that I do.

Can you elaborate on how you do that

It’s Patrick Henry who said that there’s no way of judging the future except by the past. If you look back at history over the last 75 years the companies that have shown the biggest gains – companies in different industries with different businesses run by different groups of people – have shared several common features. What I do is to scan for companies that have the same characteristics as the companies that have performed the best in the past.

A few of these features are as follows. They have double-digit sales growth because you can only increase profits by cutting costs for so long without destroying the underlying business. They have had 20 percent compounded earnings growth for the last three years. Their recent quarter’s earnings are up 25 percent or more. They tend to be generating a return on equity of 17 percent or better (return on equity is earnings divided by book value and it’s an excellent measure of management’s efficiency with firm capital).

These companies also tend to be innovators who create new services or products that attract consumers. A perfect example is Apple which came out with the ipod then the itunes music store then the iphone and the ipad. They just keep putting out new products and new iterations which drives strong top-line growth and ends up creating massive bottom-line growth. As a result Apple’s been one of the top-performing stocks of the decade.

These companies tend to have strong institutional ownership (from mutual funds pension plans hedge funds and so on). I tell investors to remember that the vast majority of the volume on the New York Stock Exchange and the NASDAQ is not from individual investors like you and me but from these big institutions. You don’t want to be buying when they are selling – that’s like swimming against the tide.

These companies tend to have strong technical indicators – increased buying on rising volume - insider buying and stock buybacks. Buybacks are a positive because when a company reduces the amount of shares outstanding you get higher earnings per share. These are just some of the things that I’m looking for – companies that are at the top of their industry and are very solid financially. I have no interest in finding beaten up ‘fallen angels’ that people think are going to spring back from the dead. There are people who can do that with some success but what I do is look for companies that are already doing well and could produce positive surprises – earnings that are higher than people expect. And that’s essentially what I’m looking for.

Turning to the political climate you’ve said that politicians almost always pursue their self-interest first which is generally a bad thing for people who are affected. What are your thoughts on the impact of the mid-term election for investors

It may be mildly positive. First of all don’t make any investment decisions based on politics. Washington is so dysfunctional and to me both parties are just so inept and corrupt that I have a hard time cheering for either side. Congress is now in the control of Republicans but they don’t have a veto-proof majority. They’re not going to give Obama what he wants and Obama’s not going to give them what they want. I think we’re in for two more years of gridlock. That’s not necessarily a bad thing. Gridlock means that bad ideas don’t get passed into law but it also means that important problems don’t get solved. In my view the latest elections are a neutral factor.

In your writing you ‘call out’ people who you say are overly bullish on gold and too pessimistic on the economy. There are some examples though of long-term economic declines happening – just not in the US. For instance Japan has been stuck in an economic slump for decades. Argentina has yet to recover from its currency disaster in 2001 and its economy is still deteriorating. Even in the US the bottom 90 percent of households are barely better off since the ’08 crash – if at all. Doesn’t this show that the US economy could ‘hit a wall’ and begin to decline

Well trees don’t grow to the sky and stock markets don’t go up forever. We’ll certainly have lots of nasty bear markets in the future. Given that this bull market is more than five and half years old a bear market could probably come sooner rather than later. When I say sooner I mean in a few weeks months or a few more years from now – it’s just hard to say. Rising and falling markets are what you should expect just like you expect an expanding and contracting economy. As far as how long the economy will expand – you just don’t know.

Let’s look at history. Say I was an Argentinian. That country is in such bad shape in so many ways that there aren’t a lot of companies operating there that I could recommend. The only ones may be companies who are somehow benefitting from the disastrous policies of the Argentine government.

For Americans and people in the West there are lots of great companies to choose from. Why you would choose to put most of your money in gold rather than profitable businesses is a mystery. Talking about history over the last 200 years gold has not only underperformed bonds stocks and money markets but it’s barely kept its head above inflation. As you know gold peaked at around 800 dollars per ounce in 1980 and it’s not kept pace with inflation for the past 37 years – so it hasn’t been much of a hedge. It certainly hasn’t been much of a hedge in the last few years since it peaked in 2011 at just under $2000 per ounce. Gold has its advantages. It’s real precious and coveted everywhere. It just doesn’t have a lot of uses besides looking pretty. I’ve even got a gold tooth in my mouth but my kids will never have a gold tooth. There are just too many substitutes that are less expensive than gold.

If you look back not just over the last few hundred years but over the last few thousand years also gold hasn’t done much except hold its value. That’s great because the dollar is worth about 1/20th of what it was before. Gold is worth more even in inflation-adjust terms. A dollar’s worth of gold at the time the dollar was created is now worth about three and a half dollars in real terms. However a dollar’s worth of stocks a hundred years ago would be worth hundreds of thousands of dollars in real terms today. When people say you should grow your wealth by investing in profitable businesses that’s absolutely right. What’s better than a profitable business A diversified portfolio of profitable businesses – and that’s beaten the pants off of gold for the last couple hundred years. My guess is that it will do so again over the next couple hundred years.

With gold down to around $1150 per ounce from a peak at over $1900 does gold look more attractive to you or are you staying away completely

I think everyone should have a position in gold. It’s sort of like how everyone should have a spare tire in their trunk – but you hope you never have to use it. If the world truly goes to hell in a hand-basket which people have been forecasting for thousands of years gold offers great short-term trading possibilities. It has real tangible value. Maybe if we had a real economic collapse like gold bugs have been predicting for decades gold might be the one thing that shines. But there isn’t even any guarantee of that. Gold might go down with everything else.

Gold’s lack of commercial possibilities isn’t its only problem. The second problem – and it’s why it’s more of a gamble than a solid investment – is that you can’t really value gold. With most investments there are metrics you can use to determine whether you think something is undervalued or overvalued. The problem with gold is that it doesn’t accrue interest pay earnings dividend or rental income. Since there is no income yield or book value there isn’t anything you can use as a yardstick of value. When people say that they think gold is over-valued or under-valued I think it’s tough to say that. You might say it will sell for above what it costs to produce but even that’s not true. It could sell for less than its production cost if we had too much supply. To me that’s the problem with gold. You can’t really determine whether it’s overvalued or undervalued at any particular time.

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Alexander Green is the Chief Investment Strategist of The Oxford Club the Senior Editor of The Oxford Communiqué and Editor of The Momentum Alert The Insider Alert and The True Value Alert. Alex’s Oxford Communiqué is ranked among the top 10 investment letters in the nation by the independent Hulbert Financial Digest.

A 25-year Wall Street veteran Alex has been profiled by The Wall Street Journal Bloomberg BusinessWeek Forbes and other media outlets.

Alex is also the author of four national best-sellers. His works include The Gone Fishin' Portfolio;Beyond Wealth: The Road Map to a Rich Life; The Secret of Shelter Island: Money and What Matters; and An Embarrassment of Riches.

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