Comparing The Dow To The Price Of Gold

Back in December of 2008, I wrote about the Dow Jones Industrial Average price relative to the price of Gold.  It was one of my first forays into the world of  intermarket analysis.  I updated it about a year ago.    Just the other day I wrote about the S&P 500 compared to the US Dollar index.  I believe there is much to be learned by studying the interactions between different markets.  It is one of the reasons I consider myself a student of all markets - not just the stock market.

The different markets act in ways that cause reactions in other markets.  Everything is connected.  What I have been looking into now are the the easy intermarket analyses.  I think you can google “dow vs gold” and get a great chart.  In fact, I did just that (below).

Tracking stocks is easy - Yahoo or Google finance make it very simple to find information about stock prices and volumes and earnings and analyst recommendations.  Tracking gold and other commodities is more difficult.  Tracking the bond market is even trickier.  Finding free places for this info is not easy.  I am going to have to pay for stockcharts.com aren’t I?  Love the site, but hate paying for anything.  Anyways, that is besides the point.  GET TO THE DOW vs GOLD TALK ALREADY

Alright, alright

When I spoke back in 2008, the Dox/Gold ratio was about 10 - which is above its long-term historical average of 9.  On the chart below, you will see that they see the long term average as 10.  This is from Fred’s Intelligent Bear Site, which I found from googling “dow vs gold” (see, I told you so).  Click for a larger chart.

This chart is very helpful because they provide a nice historical trend line, which I believe to be more relevant than a long term average.  Another thing that I’ve found to be very helpful is to look at charts of the Dow and Gold themselves - this might provide some insight.  Click for larger charts of the below.

People like to compare this market recovery to that of 1974.  There is is certainly a rhyming of 1974 to today.  The sharp recovery in the stock market after a sharp drop.  Look also at the behavior of gold after 1974 - it wasn’t long before the price of Gold went thru the roof.

There are some people who say that the price of Gold is in the process of doing the same sort of parabolic price movement.  Looks to me like it already has, but what do I know?

Not that I remember too clearly, but the late 70’s and early 80’s were a time of high inflation, high interest rates along with high gold prices.  They also gave way to the stock market boom in the mid-late 80’s.  I think some people are already thinking this is a foregone conclusion for todays’ economy and markets.

You can hear politicians and some economists warn of “hyperinflation” and comparing today’s US with the German Weimar Republic of the 1930’s.  They say buy gold because it is going to $2000 per ounce.

Slow down.  We’re not there just yet.

What we have in the ratio chart above is a ratio of approximately 10 that is below the long term trend line.  We can see that historically, the trend line can act as more of resistance than support.  I’ll explain - then the ratio dives, the trend line usually does not provide support for a bounce.  However, in the 30-50’s and again in the 70’s, the line acted as resistance.

We have to look at the Dow and Gold to see where this is going to go.

The ratio goes up because of two reasons:

• The Dow Jones Industrial average goes up
• The price of Gold goes down.

It goes down for the exact opposite reasons.

Gold - just like any other market - can be driven by news and trading activity.  I think one reason for the price increases of late is that the market is fearful of inflation.  The inflation fears come from the recent Federal reserve policy of low rates and increase money supply along with what some see as overspending by the Federal government.  Should the Fed successfully reduce the money supply and increase rates without sending the stock markets into a tailspin, I think you might see the inflation worries subside and the price of Gold will drop with it.  That does not mean it won’t see $2,000 before then …

That is one man’s take.  One student’s take.

I will keep my eye on the Dow vs Gold ratio however and see if it tells me anything.  Hopefully it won’t take me a year to write about it again.

Back last year, I mentioned that the way to make money off of this ratio was to get long Gold.  While that was not incorrect, the real trade was long the Dow - nice 50% run up (approx) - hindsight is 20/20.

I will not make a similar call at this point.  I think there are reasons to think that the stock markets will correct further.  There will also be reasons that Gold might also dip further.  At this point, I would not be a trader in these markets.  I’m becoming less interested in short term and looking more into long term asset allocation.  From an allocation point of view, I think owning both stocks and precious metals is important in one’s portfolio.

How is that for a cop-out?!