Gold/Dow Ratio: Where Are We Holding?

By Adrian Ash

If Wall Street stocks can surge 160 points on falling earnings, an 11 percent drop in housing starts, and a 16-year record for consumer price inflation, then so can everything else that doesn’t carry a picture of George Washington.

Crude oil, rice, gold, the euro, wheat, emerging market bonds, copper...anything that’s not stamped with the all-seeing eye of the dollar looks like a great bet once again. The Federal Reserve has seen to that, driving the real returns paid to cash down toward a three-decade low.

Sinking to minus 2.05 percent in March, the real rate of interest nearly equals the very worst returns to cash paid during the Great Greenspan Reflation of 2002-2005. This latest slump in real interest rates also comes thanks to “emergency” rate cuts.

Plus, of course, the worst run for consumer price rises since the start of 1992. And I think the two are more closely related than the Olsen twins:

Rates down, inflation up? Well, what else did savers and retirees expect? The Fed can’t promise to forestall recession forever. But by God, it will try!

So for the meantime at least, there’s truly no fear of deflation here.

Whatever happened to the Fed committee’s much-expected “moderation” of inflation? Running at 4.3 percent yet again in March, the CPI just put in its longest stretch above 4.0 percent in 16 years.

Where’s the “projected leveling out of energy and other commodity prices” it promised only last month? Crude oil recently broke fresh records above $114 per barrel, and rice prices — worldwide — have doubled from where they stood in October.

It’s not just U.S. cash savers being eaten alive, of course, by subzero rates of real interest. Here in London, the real returns paid to savings after tax and inflation have sat in the red for the last five years running. The latest shop price data from Europe now show a 12-year record for German consumers, giving the lie to “inflation vigilance” at the European Central Bank.

But the sudden bull market in everything really stands out in dollar terms. And hoarding cash — the true meaning of “deflation,” as well as the root cause of the current worldwide crisis in banking — has become a sure route to the poorhouse again.

How to choose the best escape route for your savings and wealth? Clearly, real estate’s doomed, for the short to midterm at least. Government bond yields are now so far underwater you’d be killed by the bends if they tried to come up for air.

That leaves commodities and stocks, the classic refuges for inflationary crises. And one way of judging the Dow — free from all dollar distortions — is to measure the index in terms of gold ounces:

Dividing the Dow Jones industrial average by the price of gold gives you a rough idea — over time — of where the real value might lie. It shows how many ounces of gold you would need to buy one unit of Dow stocks.

Hence, gold was a raging sell (in hindsight, at least) when the Dow/gold ratio touched 1.0 at the start of the 1980s. Stocks scarcely looked back for the next 20 years. But by the end of the ‘90s, the real value had shifted again. And gold surged as the Dow sank after the tech stock crash of 2000.

That slump in stock prices compared with gold pushed the Dow/gold ratio down from its all-time top above 42.2 to just 12.6 in March of this year.

That’s pretty much exactly the Dow/gold average of the last 80 years. So which way will the ratio go now?

The Fed’s new “reflationary melt-up” is clearly designed to keep stock prices buoyant. But it’s only adding to the case for gold, too. “I would be very surprised if the Dow Jones industrials/gold ratio didn’t decline to between 5-10 within the next three years,” said Marc Faber of The Gloom Boom & Doom Report recently.

If that call proves right, it might come thanks to gold prices doubling, or stock prices halving, or more likely some combination of both. But while the three peaks to date — of August 1929, January ‘66, and then late ‘99 — took the Dow/gold’s top higher, the floor only held steady, down there at 2 ounces of gold and below.

And the last slump — during the inflationary 1960s and stagflationary ‘70s — took a full 14 years to work itself out. So far in this bear market for the Dow/gold ratio, we’re nine years through to date.

Comments

[E.D. Hart]

As near as I can tell, when the ratio line drops below the average it is approximately 20 years until the average crosses the line on the upside.

Since we are just crossing to the downside now, this suggests another 20 years below average--If the past if predictive of the future.

Thats a pretty big if. I agree with the broad brush strokes of this theory, but not the application of years to go in the trend.

As this recent stock bull market and gold bear market was quite extreme, we may see much longer to work through the excesses of inflation and pent up commodity demand---in other words, the peak to peak may be much longer as this last peak was more pronounced.

Theretofore, golds recent out-performance may last a lot longer than the authors article states.

We also have the additional phenomenon of central bank gold hoarding that skewed the picture in the 80's and 90's.

As the dishoarding comes to an end, and other newly powerful banks come into the markets for gold...we will see a more natural gold demand. (i.e.-not subject to government manipulation to the same degree).

or not.

[mark mchugh]

Great article

[ussmls7]

I love the I,e.- not subject to gov manipulation to the same degree. Just think, if the goverment lost all its support to act in its name, what would be?

[pdd]

Interesting, but no real help for future planning.

[deuxsous]

In the idealized economic long wave cycle there are 27 years of inflation followed by 27 years of disinflation. Due to the time expended for basing of disinflation (1998-2003) and the time expended for the topping of inflation (1974-1980), the actual trend periods of inflation and disinflation are a bit over twenty years each. If we take 2003 as the time when the basing of disinflation completed, then inflation will rise on a trend basis until 2023 or so. And with inflation go interest rates and gold and other commodities.

The Dow/Gold ratio shows that selected stock sectors can still rise during gold's inflation, but overall stocks don't rise as much as gold, especially the Dow which rarely has a metals stock, although the chemicals and oils can do well.

Commodities and gold tend to rise in quantum leaps followed by long consolidations, so it is advisable to get a broad exposure to many commodities such as in the Dow Jones-AIG Index or the Continuous Commodity Index (Son of CRB). Not every commodity moves together and at the same time, so indexing serves to dampen volatility. DJP and GCC are two ETF's which follow DJ-AIG and CCI respectively. Pimco's PCRIX/PCRDX does the same in the mutual fund format.

I personally own GCC and PCRIX but have no other connection with the gold or commodity industry.