Dow/Gold Ratio Hits 7; Multi Decade Low
Thursday, March 5, 2009 19:34In our 2009 forecast, we mentioned that the Dow Jones/Gold ratio would likely hit 5 this year. A milestone was reached today as the Dow Jones index made a fresh 20 year low in terms of gold. The ratio has fallen to 7, down from the 1999 peak of 42.5 ounces.
Seven 1 oz. gold eagle coins buys the Dow Jones.
The chart below was one of the primary reasons we warned of a coming stock market crash back in 2007.The top half shows the Dow Jones priced in ounces of gold while the bottom is the Dow Jones cash index (the one you normally hear about). Notice that BOTH lines were rising and making new highs throughout the 80s and 90s bull market.
Now look at the two lines diverge when the last “Bull Market” began in 2002 . From 2002 to 2007, the Dow Jones was making new all time highs, as the Dow/Gold ratio was making new lows, an unusual occurrence in a true bull market.
So why would this happen? The answer is INFLATION. The 2001 recession was a VERY serious one, and the big fear at the time was Japanese style deflation. One way to combat deflation is to cause inflation and so rates were cut, credit was expanded and liquidity ballooned. The effect, of course, was a devaluation of the US dollar. As the dollar gets weaker, its takes more of them to buy things or, in this case, the Dow Jones.
The weak dollar caused the price of nearly everything to rise and stocks were no exception. When we eliminate the movement which was caused by dollar depreciation by charting the Dow in terms of real things such as gold, oil or other commodities we get a much better idea of whats going on.
The chart below shows the dollar falling through 2002-2007 while stocks were rising.
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frank scott says:
March 6th, 2009 at 10:41 am
I wish I knew about this site in 2007 Would have saved my retirement accout. Thanks for your work
poorrichard says:
March 6th, 2009 at 11:01 am
Do you figure it will go to a 1 to 1 ratio?
Anonymous says:
March 6th, 2009 at 11:19 am
Yes!, let’s keep pumping on the gold bubble! When we all start selling or trading in gold I’ll like to see the gurus finding out the next safe heaven.
But sure, there are major players taking advantage, as usual.
steve brown says:
March 6th, 2009 at 3:42 pm
This reflation is just another throw of the dice, then. The quantative easing in Britain is not a response to this current crisis, but a last throw of the dice in the ongoing 21st. century economic crisis. Thanks for the historical context here – clear, precise and frightening. Top!
Global News (03/06/09) says:
March 6th, 2009 at 6:22 pm
[...] Dow/Gold Ratio Hits 7; Multi Decade Low (Charting [...]
Jeffry Pilcher says:
March 9th, 2009 at 3:39 pm
I think the ratio will hit something closer to 2.5:1 or 3:1. The market isn’t done going down, and gold isn’t done going up. Also, as you point out in the charts above, people don’t understand how inflation works. ••••• You hear a lot of people talk about gold like it’s some sort of “psychological play” — that it has no real value outside of what people THINK it has. These folks suggest that people are buying gold as a “doomsday hedge.” They say that if the apocalypse comes that gold will be worth nothing. But can’t you say the same thing about ANY investment? Aren’t stocks simply worth “what people THINK they’re worth?” Wouldn’t all asset classes crash to zero in an apocalyptic scenario?
Heartburn Home Remedy says:
April 15th, 2009 at 6:06 am
Hey, nice tips. I’ll buy a glass of beer to that person from that forum who told me to go to your blog
Stephan says:
November 1st, 2009 at 11:48 am
Many people are arguing if we are going into a inflationary or deflationalry period. THe beauty of the DOW:GOLD ratio is that if you believe this long term trend ends at around 1 it does not really matter if we go into a deflationary or inflationary period. Short the S&P and go long in gold and you should be in good shape in the long run!!!
Chris says:
November 20th, 2009 at 12:21 pm
This also means the Fed is going to need to tighten money policy and raise interest rates. Bad timing for that.
Jeff says:
February 11th, 2010 at 10:47 am
It’s a little sketchy to price the dow in 1 oz. gold eagles. You shouldn’t be adding numismatic value to gold when comparing it to the dow. Just use the spot price.
Chris says:
February 18th, 2010 at 3:02 pm
If only you included the phrase “buy buy buy” (sorry for hte cramerism)
I think the ratio did in fact tell us of the bottom. I wonder what the ratio is telling us nowhttp://studentofmarkets.com/?p=1332
I wrote a little about the Dow/Gold today and thought I would share. It’s going to be worth watching