Prepare for a Lower Dow to Gold Ratio

Assets are continually revalued against one another in an ongoing process to determine proper valuations. Investor preferences move in big waves, from paper assets to hard assets. The decades of the 80's and 90's were clearly periods when paper assets such as stocks, bonds, and derivatives performed exceptionally well. That era of paper wealth is gone for now, as evidenced by the mass failure of financial institutions last fall, and we have entered into a period when hard assets are in vogue.

The Dow to Gold ratio is a useful tool to track this process of asset reallocation, since gold is the ultimate hard asset. Usually, when hard assets enter into a bull market, the Dow to Gold ratio goes to under 5. For example, the ratio hit 1 in 1896, 2 in 1932, 3 in 1974, and 1 again in 1980. The current bull market in gold has brought the ratio from a high of 44 in 1999, to its current reading of 10.

In addition, there seems to be a tendency for the ratio to "overshoot" on the downside based on how overextended the ratio becomes. For example, an 18 Dow:Gold ratio eventually fell to 2 in 1932, and a 27 Dow:Gold ratio eventually fell to 1 in 1980. Considering that the Dow:Gold ratio was at 44 prior to this move, it looks like we still have a long way to go on the downside.

The decade-long move in gold may seem overextended, but there are still several bullish factors working in gold's favor. First, gold has been able to trade above 900 since the supposed recovery in the economy and massive rally in stocks beginning in March. A similar consolidation pattern in gold in 2006 preceded a 50% surge in prices. Anyone familiar with fractals is eying this pattern and its potential completion. Second, gold has been able to rise along with the dollar index, which is usually a bullish signal. Third, we are moving into a historically bullish season for gold.

With stocks overpriced at over 100 times reported earnings, a decent-sized pullback is in order. Therefore, I expect the Dow to Gold ratio to decrease in the coming months and years. Nonetheless, keep an eye on the Dow to Gold ratio as an indicator of investor sentiment and the relative valuation of asset classes.

Comments

[Larry House:]

Not all stocks are selling at 100-times earnings. That is why one can be selective even here. This is a poor time to buy an index, in my view, but a good time to be a stock picker. I agree with the switch in sentiment toward hard assets, and every portfolio should have some. I prefer silver to gold, but I have no argument with holding gold bullion as well.

Sep 02 12:26 PM

[ker.nulov@g...:]

test

Sep 02 03:01 PM

[ker.nulov@g...:]

see Kim, there has been so many bullishness in gold, that it is just an excellent short at current 976 . gold is buliish because:
- september is just excellent
- dow/gold ratio is going to 1
- stock markets are gonna fall (i.e. people will rush to safety - gold)
- money printing, and such blah blah blah
Nobody actually sees that gold has now 3 attempts to break 1000 and it couldn't. It makes lower lows on every attempt. Moving DOW/GOLD averages are pushing higher and treaten to do a golden crossover. I was expecting it to reverse at 9, but it now at 10. Gold at this time (technically) is a sell signal. Yeah, gold is going into a nasty bear market for 2 years, to bottom around 500. The trend should start on london close on thursday with following big selloff on friday 4 sep somewhere to 920-930.

Sep 02 03:12 PM

[GMiki1:]

User, I read ALL the real (experienced) gold analysts and the most bearish of them agrees that gold is in a long-term bull. You're making a big mistake. But then again, we all make mistakes and lose money.

Sep 02 04:24 PM

[Celcius:]

User, Gold has the potential to fall in the short-term, but it depends on investor sentiment toward US treasuries. As Alt-A, Option Arm, and Commercial Real Estate loans devastate US banks balance sheets, equity investors may flee to the safety of gold bullion, causing a gold demand spike, vs. US treasuries despite massive deflation in the money supply. Or they flee to US treasuries and the price of gold drops due to the deflationary pressure on the money supply.

There is certainly a tipping point where investors will lose confidence in the ability of the US government to replay debt, especially during high rates of deflation, and opt for an alternative medium of exchange vs. the dollar. In the next few years IMO gold will fill this void until the world economy recovers and a risk averse fiat currency appears.

Disclosure: 10% gold bullion position & 1% gold equity position

Sep 02 07:25 PM

[Mad Hedge F...:]

weqrt. ) Just as it is prudent to top up your flood insurance ahead of the hurricane season, investors are loading up on gold ahead of the treacherous September-October stock trading period. Yesterday’s $22 move up shows that attempt number six to run the yellow metal up to a new high has begun. Silver happily tagged along for the ride, tacking on 70 cents to $15.49. Historically, September is the best month of the year to own the barbaric relic, showing an average 3.5% gain over the last 20 years. The onset of the Indian wedding season, Ramadan, and the run up to the Christmas and the Chinese New Year jewelry buying binge are all conspiring to give gold a boost. A tip off this was coming was the big put selling seen for the shares of the gold ETF (GLD), and Kinross (KGC). One good way to play gold at this late stage might be the shares of highly leveraged unhedged producers like Rangold resources (GOLD), Jaguar Mining (JAG), and royal Gold (RGLD). Confirmation that the markets are moving towards risk aversion can be found in the euroyen chart, which hit a one month low at 131, after double topping at 140.50. If gold does break, it could tack on 20% very quickly to $1,200. Keep those American gold eagles.

Sep 03 11:01 AM

[Graham and ...:]

We use 5 as the midpoint for this ratio, meaning that it's "over" in a bear market for gold, and "under" in a bull market. We're still not in a bull market.

Sep 03 11:05 AM

[granger:]

I have a question. Why is it compared to the DOW. Is there any credence to using the S&P 500 or Russell 3000. (maybe Wilshire 5k)

I would be interested in the authors thoughts

Sep 03 12:06 PM

[Moses Kim:]

granger,

The S&P would work just as well, if not better, in my opinion. However, the S&P has only been around since 1957, so it's hard to extrapolate from historical data in the same way that you can with the Dow.


On Sep 03 12:06 PM granger wrote:

> I have a question. Why is it compared to the DOW. Is there any credence
> to using the S&P 500 or Russell 3000. (maybe Wilshire 5k)
>
> I would be interested in the authors thoughts

Sep 03 03:54 PM

[Zmartmoney:]

Please note the reasons that gold keeps bumping up against 1000.
1. Central banks around the world start shorting gold to scare investors.
2. Central banks worldwide, including IMF, are ready to quietly dump out gold to push down the price.
3. Central banks around the world collect gold mining stocks during each pullback, then start selling them off to depress stock prices whenever gold hovers in the high 900's.

This is a blatant attempt to manipulate the markets, especially in the U.S. The Fed and Treasury are soiling their britches each day that gold starts a run. They throw themselves at it like it was the last 100 yards of the marathon - it may be - that will only work so many times before gold breaks out, and then, Katie bar the door. I expect it will run all the way to 1300 and then slowly slide down to 1100. Following that it will likely start a slow, steady climb that no one can stop until...??? I guess we'll see what the velocity of money looks like next spring. For the fall and summer it's about to be naptime, with the market having priced in all the expected inflation for the next year. Sweet dreams.


On Sep 02 03:12 PM [e-mail] wrote:

> see Kim, there has been so many bullishness in gold, that it is just
> an excellent short at current 976 . gold is buliish because:
> - september is just excellent
> - dow/gold ratio is going to 1
> - stock markets are gonna fall (i.e. people will rush to safety -
> gold)
> - money printing, and such blah blah blah
> Nobody actually sees that gold has now 3 attempts to break 1000 and
> it couldn't. It makes lower lows on every attempt. Moving DOW/GOLD
> averages are pushing higher and treaten to do a golden crossover.
> I was expecting it to reverse at 9, but it now at 10. Gold at this
> time (technically) is a sell signal. Yeah, gold is going into a nasty
> bear market for 2 years, to bottom around 500. The trend should start
> on london close on thursday with following big selloff on friday
> 4 sep somewhere to 920-930.

Sep 03 10:23 PM