Dow/Gold Ratio: Where Next?
By Adrian Ash
April 18, 2008
Forty years of inflation vs. 80 Years of pricing
the Dow Jones in Gold...
IF WALL STREET STOCKS can surge 200 points on falling earnings,
an 11% drop in housing starts, and a 16-year record for consumer-price inflation
– just as the Dow Jones Industrial Average did on Wednesday this week – then
so can everything else.
Everything else that doesn't carry a picture of George Washington,
that is.
Crude oil, rice, Gold,
the Euro, wheat, emerging market bonds, copper...anything that's not stamped
with the Dollar's all-seeing eye looks a great bet once again. The Federal
Reserve has seen to that, driving the real returns paid to cash down towards a
three-decade low.
Sinking to minus 2.05% 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, too.
Plus, of course, the worst run for Consumer Price rises since the
start of 1992. And here at BullionVault
we 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
either inside or out of the United States.
Whatever happened to the Fed Committee's much-expected
"moderation" of inflation? Running at 4.3% yet again in March, the CPI
just put in its longest stretch above 4.0% in 16 years.
And where's the "projected leveling-out of energy and other
commodity prices" it promised only last month? Crude oil just broke fresh
records above $115 per barrel and rice prices – worldwide – have doubled
from where they stood in October.
It's not just US cash savers being eaten alive, of course, by
sub-zero rates of real interest. Here in London, the real returns paid to UK
Savings After Tax & Inflation have sat in the red for the last five
years running. The latest shop-price data from Europe now shows a 12-year record
for German consumers, giving the lie to the European
Central Bank's "Inflation Vigilance".
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 poor-house again.
How to choose the best bolt-hole for your savings and wealth?
Clearly real estate's doomed, for the short to mid-term 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 eighty
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 and 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 Aug. 1929, Jan. '66 and then late
'99 – took the Dow/Gold's top higher, the floor only held steady, down there
at two 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.