Ever since the March 2009 crash low in the U.S. equity markets, I’ve maintained my view that the Dow Industrials and other broad market indices were entering a new bull market. That forecast has been spot on.
One of the tools I used to come to that conclusion in 2009 was the ratio of the Dow Industrials to the price of gold.
I wrote extensively about it in several issues of my Real Wealth Report. I also reported on it several times in other pieces I wrote. Today I want to update the analysis for you.
First, a refresher. At the peak of the Dow/gold ratio in 1999, the Dow Industrials would have purchased just over 50 ounces of gold. That’s because the Dow was at a high in real, inflation-adjusted terms, while gold was at its bottom at the $255 to $275 level.
During the financial crisis of 2007-2009, as equities plunged and gold rallied (since its bottom in 1999), the ratio collapsed all the way down to the 6 to 7 level.
In other words, in terms of gold — what I like to call “honest money” — at its March 9 low, the Dow had lost more than 87 percent of its entire equity bull market from 1980 to 1999.
Since then, the major averages have vastly outperformed gold, as stocks have moved higher, and gold lower.
As a result, the ratio of the Dow Industrials to gold has widened back out, to about a level of 16.4 today.
Put another way, had you bought the Dow Industrials in 2009 at the bottom and sold gold, you would have made well over 250 percent on your money as the Dow soared and gold plunged.
So what does this all mean? And what does it hold for the future for the Dow?
|The Dow/gold ratio is not easy to grasp, yet it’s critically important.|
I’ll answer those questions now. But I urge you to put your thinking cap on, because the analysis of the Dow/gold ratio is not easy to grasp, yet it’s critically important for understanding the future.
FIRST, the collapse in the Dow to gold ratio was not caused simply by a crash in equity prices. It was also due to a crash in the value of the dollar, as reflected in the soaring value of gold from the year 2000 to 2008.
SECOND, the Dow is still adjusting to how much value the dollar lost between 2000 and 2008.
This adjusting of equities is perfectly normal. All asset classes eventually recalibrate their price levels to the new reality of the purchasing power of the underlying currency, which, in this case, is the dollar.
A simple theoretical exercise here will show you how the Dow will adjust.
For the Dow/gold ratio to climb back to the 50 level — where it was when stocks peaked in 2000 and gold bottomed …
The Dow would have to explode higher to the 58,250 level, assuming gold’s current price of roughly $1,165.
Naturally, the price of gold is not going to remain at $1,165.
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So let’s say gold does indeed fall further now, to say, $1,000 for argument’s sake. Then a 50-to-1 ratio for Dow/gold, with gold at $1,000, would still imply the Dow eventually hitting the 50,000 level.
Naturally, projections like that assume all else remains equal. In other words, the underlying economy, unemployment, international relations, the global economy and a host of other variables.
So those projections are not realistic.
But what is realistic is this: It would not be unusual at all, in fact, it would be perfectly normal if the Dow/gold ratio were to regain half of what it lost since the year 2000 …
And move back to the 25 level.
Then, all we need to do is pop in various prices for gold to get various measurement of how high the Dow can go. Assuming gold does bottom at $1,000 and then begins its next bull market, we can then come up with a grid that looks something like this:
|Gold Price||Dow/Gold Multiplier||Dow Industrials Price|
Put any number in the first column for gold, and you can come up with any slew of other numbers for the Dow.
It’s certainly not hard to see why the Dow also has huge upside potential going forward and that its downside is limited to mere technical corrections!
Factor in the war cycles and other geo-political forces that are driving capital to the U.S. stock markets …
And you can easily see why I remain very bullish long term on the U.S. stock markets and why my long-term target of Dow 31,000 may actually end up conservative.
Lastly, an important point: As you can tell from this exercise, the monetary system has changed dramatically.
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So much so that it’s also inevitable that at some point in the not-too-distant future, the dollar-based reserve system will have to change.
Even as the dollar now rallies, the system is so broken and so out of date with the rest of the world and the emerging economies and Asia, we will eventually need a new reserve system with a globally neutral reserve currency.
One last note: Although the Dow has now given me a monthly buy signal by closing above 18,500 …
A pullback, possibly a very sharp, drawn-out one, is way overdue. I do NOT recommend loading up on stocks here. Not yet. Also, gold and silver remain in a funk, deeply oversold. There too, it’s not yet time to get aggressive.
We may indeed see gold and silver a tad lower early next year, but they are scraping the bottom now and deeply oversold, ready for a rather big bounce.
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