The Investment Seesaw

Steven Saville profile picture
Steven Saville
1.5K Followers

Summary

  • A point we’ve made many times in the past is that gold and the world’s most important equity index (the S&P500 Index - SPX) are at opposite ends of a virtual investment seesaw.
  • With regard to the gold market, the aforementioned attempts failed first and foremost because the underlying premise is wrong, in that, there is no good reason for the gold price to track the US money supply.
  • If we are right to think that an economic bust (a 1-3-year period of declining confidence) has begun, then this suggests that there is a lot of scope for the gold price to increase over the next couple of years even if the pace of money-supply growth is slow.

Man looking at currency trading app on his smart phone from his home office

Alistair Berg/DigitalVision via Getty Images

Editor's note: Originally published at tsi-blog.com on June 11, 2022

[This blog post is an excerpt from a TSI commentary published on 5th June 2022]

A point we've made many times in the past* is that gold and the world's most important equity index (the S&P500 Index - SPX) are at opposite ends of a virtual investment seesaw. Due to their respective natures, if one is in a long-term bull market, then the other must be in a long-term bear market. In multi-year periods when they are both trending upward in dollar terms, it means that the dollar is in a powerful bear market, not that gold and the SPX are simultaneously in bull markets (the one that is actually in a bull market will be determined by the performance of the gold/SPX ratio). Recently, our 'investment seesaw' concept was part of the inspiration for the Synchronous Equity and Gold Price Model (SEGPM) created by Dietmar Knoll. This model is a quantitative relationship between the SPX, the US$ gold price and the US money supply (the model uses the M2 monetary aggregate), and is explained on pages 251-266 of Incrementum's latest "In Gold We Trust" report.

Before delving into how the SEGPM works, it's worth pointing out that there have been previous attempts to link changes in the stock market and the gold price to changes in the money supply. These attempts failed. With regard to the stock market, they failed because a strong positive correlation between the senior equity index and the money supply only exists during equity bull markets, that is, the money supply in isolation fails to account for the major swings in the stock market. For example, during the 9-year period, from March-2000 to March-2009, there was huge growth in the US money supply, but the SPX was 50% lower at the end than it was at the start of this period.

With regard to the gold market, the aforementioned attempts failed first and foremost because the underlying premise is wrong, in that, there is no good reason for the gold price to track the US money supply. Also, we know from the historical record that valuations for gold that are based solely on the US money supply can deviate hugely from the real world for decades at a time, which means that they have no practical value.

The sorts of models mentioned above have never worked over complete cycles because they consider the SPX and the money supply or gold and the money supply, as opposed to an SPX-gold combination (both ends of the 'investment seesaw') and the money supply.

The SEGPM is based on the idea that there are periods when an increase in the money supply will boost the SPX more than it will boost the gold price and other periods when an increase in the money supply will boost the gold price more than it will boost the SPX, with the general level of trust/confidence** in money, the financial system and government determining whether the SPX or gold is the primary beneficiary of monetary inflation. During long periods, when trust/confidence is high or trending upward, increases in the money supply will tend to do a lot for the SPX and very little for gold. The opposite is the case during long periods when trust/confidence is low or falling.

Dietmar Knoll found that adding the SPX to 1.5-times the US$ gold price (and applying a scaling factor) resulted in a number that has done a good job of tracking the M2 money supply over many decades. The correlation is illustrated by charts included in the above-linked Incrementum report, but we have created our own charts using True Money Supply (TMS) instead of M2. Our charts are displayed below.

Each of the following two monthly charts compares the US TMS with the sum of the S&P500 Index and 1.5-times the US$ gold price. The only difference between these charts is the scaling of the Y-axis. The first chart uses a linear scale and the second chart uses a log scale.

The Investment Seesaw
The Investment Seesaw

The log-scaled chart displayed above indicates that since 1959, there have been only three multi-year periods during which the SEGPM deviated by a substantial amount from the money supply. The first was during 1969-1971 due to the extreme under-valuation of gold (the gold price was fixed at the time and unable to respond to the monetary inflation and declining confidence of the time). The second was during 1979-1980 due to a gold market bubble. The third was during the second half of the 1990s due to a stock market bubble.

Interestingly, both charts indicate that the current SPX + gold level is low relative to the money supply. If we are right to think that an economic bust (a 1-3-year period of declining confidence) has begun, then this suggests that there is a lot of scope for the gold price to increase over the next couple of years even if the pace of money-supply growth is slow. To be more specific, it suggests the potential for the US$ gold price to double over the next two years with TMS growth of only 5% per year.

*For example, in the May-2017 blog post linked HERE

**The general level of trust/confidence is quantified by our Gold True Fundamentals Model (GTFM)

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

This article was written by

Steven Saville profile picture
1.5K Followers
I graduated from the University of Western Australia in 1984 with a degree in electronic engineering and from 1984 until 1998 worked in the commercial construction industry as an engineer, a project manager and an operations manager. I began investing in the stock market 2 months prior to the 1987 stock market crash and thus quickly learned about the downside potential of stocks. Only slightly daunted by the rather inauspicious timing of my entry into the world of financial market investments, my interest in the stock market grew steadily over the years. In 1993, after studying the history of money, the nature of our present-day fiat monetary system and the role of banks in the creation of money, I developed an interest in gold. Another very important lesson soon followed: gold may be the ideal form of money for those who believe in free markets and a wonderful hedge against the inherent instability of the government-imposed paper currencies, but it is not always a good investment. By mid-1998 the time and money involved in my financial market research/investments had grown to the point where I was forced to make a decision: scale back on my involvement in the financial world or give up my day job. The decision was actually quite an easy one to make and so, at the beginning of 1999, I began investing/trading on a full-time basis. My major concern in deciding to pursue a career in which I devoted all of my time to my own investments was that I would miss the personal interaction that had been part and parcel of my business management career. The Speculative Investor (TSI) web site was launched in August of 1999 as a means for me to interact with the world by making my analysis/ideas available on the Internet and inviting feedback from others with similar interests. During its first 14 months of operation the TSI web site was free of charge, but due to the site's growing popularity I changed it to a subscription-based service in October of 2000. Its popularity continued to grow, although I remained -- and remain to this day -- a professional speculator who happens to write a newsletter as opposed to someone whose overriding focus is selling newsletter subscriptions. My approach is 'top down'; specifically, I first ascertain overall market trends and then use a combination of fundamental and technical analysis to find individual stocks that stand to benefit from these broad trends. This approach is based on my experience that it's an order of magnitude easier to pick a winning stock from within a market or market sector that's immersed in a long-term bullish trend than to do so against the backdrop of a bearish overall market trend. Fortunately, there's always a bull market somewhere. I've lived in Asia (Hong Kong, China and Malaysia) since 1995 and currently reside in Malaysian Borneo.
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