Wednesday, March 14, 2012

The Dow Gold Ratio (Updated)

Reading some gold blogs today many seemed very frustrated that gold got hit again. On this site, I believe gold is an investment for long term wealth preservation while central banks keep printing. That's why the blog is called Macro Wealth Preservation and not "hot stock tips". I can't pick stocks. I can however usually spot macro economic trends and usually can profit from it.

With today's sharp move down in gold I thought I'd review some of the historic reasons I have been a gold bull for the past several years.Some people think two quarters from now is the "long term". I like to go a bit further to put things in perspective by looking at historical information. History often repeats itself, especially economic history. The Dow to Gold ratio can give us a long historic perspective. The ratio is simply the price of the Dow compared to the price of gold. Today the Dow finished at 13,194 while gold is about $1,642 or a ratio of about 8. There have been times though that the Dow ratio has approached or hit 1:1. Below I present the historic graph of this ratio:

Notice that the ratio approaches close to 1:1 after the 1929 crash. At this time we had a gold standard, the price was fixed. The entire ratio movement came from the decline of the Dow. In the 1970's, you may recall from previous posts that the US ended the gold standard on August 15th, 1971. The price of gold was allowed to float while inflation and oil shocks pushed the Dow down. Finally, notice the ratio has been in decline since 2000 when the dot com bubble burst. The graph ends at 2009, but as I showed above, the ration is about 8 today, continuing its decline.

Will it make it back to 1 again? Every fundamental analysis shows it should continue moving in this direction. The western world and Japan are still printing like crazy. QE never ended, it just continued under new names like "operation twist" and LTRO in Europe. The world has too much debt, more than can be repaid given reasonable GDP growth rates, The only other option is to print and thereby inflating the debt away.

What reminded me of the Dow/Gold ratio were two clips I recently saw: the one I posted Monday where Jim Rickards noted that gold should be around $7,000 given the money supply and a post from Charles Biderman of TrimTabs up in Marin who believes the Dow would go to 6,000.

So one expert thinks the Dow should be around 6,000 while another believes gold should be about 7,000. Assuming these are rough numbers, wouldn't that bring us to about a 1:1 ratio?

While reading comments at I found this link to an article on this subject that has more up to date graphs and information. Its a must read and you can find it here.

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