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Gold is once again above $1,700
and eyeing its all-time high. Yet, the same two camps are saying the same
things they have since the yellow metal was at $600: either this is a
bubble, or it's headed much higher. While the gold bulls have clearly
been right for over ten years, that doesn't mean they will always be
right. There are many ways to determine whether gold will continue its
historic climb. In the past, I have looked at gold fundamentals - such as
monetary inflation, increasing government deficits, and an unsustainable
debt - all which indicate a bullish future. Today, I am examining a
technical bellwether which has been used for decades to analyze the
relative performance of stocks vs. gold.
The S&P 500-to-gold ratio
measures the value of the stock market relative to gold. When the ratio
is high, stocks are considered expensive relative to gold, and vice
versa. This is used as an "adjustment factor" that isolates
stock market performance from the effects of monetary expansion. In other
words, if the S&P 500 were rising in nominal terms but the ratio to
gold were falling, investors holding the S&P 500 would be losing
wealth in real terms.
As you can see in the chart below,
between 1980 and 2000, the S&P 500-to-gold ratio rose from 0.17
(stocks cheap) to 5.46 (stocks expensive). This rise in stocks vs. gold
was led by an American business renaissance and real wealth creation,
fueled by deregulation, technological progress, and globalization.
Unfortunately, the US government chose to squander this progress with
massive printing, borrowing, and bailouts.
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Data sources: Plan B Economics, Measuring Worth,
World Gold Council, and Robert Shiller
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By 2000, Washington's bad habits
finally caught up to the private sector and the S&P 500 tipped into a
colossal decline relative to the price of gold. This period, which is
still unfolding, is marked by eroding real wealth, systemic financial
stress, and inflationary pressures. Since 2000, stocks are more-or-less
flat in nominal terms, but this falling ratio implies that the real value
of the S&P 500 has plummeted. During this period, investors who owned
gold saw their purchasing power rise relative to those who held stocks.
By looking at the historical range
for the S&P 500-to-gold ratio, one can infer the extent to which a
gold bull market can run. The question I often get is, "Gold has
rallied for over a decade - how high can it go?" While there isn't a
'correct' S&P 500-to-gold ratio, historical bounds provide a useful
guideline:
- The current S&P 500-to-gold ratio is
about 0.778. To hit the ratio's post-war low of 0.17, witnessed in
the summer of 1980, the S&P 500 would either have to fall by
about 78% or gold would have to rise to approximately $7,850/oz (or some combination of the two).
- Looking
back at the entire history of the S&P 500 and its predecessor
indices (see chart below), the ratio was as low as 0.156 in 1878 and
was consistently under 0.5 for half a century. To reach the 1878
low, the S&P 500 would either need to fall by over 80% or gold
would need to rise to roughly $8,800/oz
(or some combination of the two).
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Date sources: Plan B Economics, Measuring Worth,
World Gold Council, and Robert Shiller
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The S&P 500-to-gold ratio is
just one of many ways to evaluate the gold bull market. While I can't
predict the future prices of the S&P 500 or gold, this short
historical analysis illustrates that today's ratio is not even close to
treading on new territory. Until the gold fundamentals change, I believe
that the yellow metal will continue to outperform stocks.
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