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Dividing the
Dow Jones index of stocks by the Gold Price80
years after its low...
Plenty of
people pay close attention to the Dow/Gold Ratio. Eighty years after it sank
to its Great Depression low, you might want to take a look this week, too.
This blunt
measure of stocks versus stuff gets nearly 5
million results on Google, posting some 650 unique stories on the
Dow/Gold Ratio. Search volumes for the term "Dow Gold" don't quite
match "Kim Kardashian" say, over the last
5 years (nor even "Reggie Bush"). But spiking in late 2008 and
mid-2011, they very nearly matched search
volumes for "Treasury bonds" - a market priced at twice the
value of all the gold in the world. So why the interest?
The Dow/Gold
Ratio maps, over time, how the Dow index of US stocks is performing in terms
of gold, rather than just in nominal dollars. Dividing the number of points
in the Dow Jones Industrial Average by the Dollars in the gold price per ounce is
simple enough. The aim is more complex - to show how investing in corporate America
- the "world's most successful economy", as Harvard professor Niall
Ferguson reminds
us - is doing versus a lump of non-yielding, relatively useless metal
that does so little, it doesn't even rust.
Investment in
Corporate America was doing very badly 80 years ago today, for instance. As
the Great Depression really got motoring, the Dow/Gold Ratio marked
Independence Day by dipping to its lowest reading
since 1900, just after the Dow Jones Industrial Average was first born.
That Friday,
8 July 1932, the Dow closed at just 41 points, while the gold price held firm at
$20.67 per ounce, then its official price as mandated by the United States'
Gold Standard Dollar. Priced in gold (which was still money back then), the
US stock market dipped below 2.0 - and showed a drop of over 90% from its
peak of only three-and-a-half years before, hitting what then proved its
lowest level of the 20th century.
Yet US Inc.
came to do worse still compared to the gold price in January
1980, however, when the Dow/Gold Ratio fell to just 1.0 - down more than 96%
from its new record high of New Year 1966. So today's equity investors might
take heart from the last 10 months' turnaround. Because sliding from the Tech
Stock Bubble's new all-time peak above 40, the Dow/Gold Ratio has risen after
hitting a two-decade low beneath 6.5 in September 2011.
Indeed, the
Dow Jones index has outpaced the gold price by 25% since
last summer. Just think what the outperformance would have been if,
say, Apple had been added to the Average instead of, say, Cisco when the
Dow was last updated in 2009.
But that's
the problem with taking the Dow as a serious guide to anything much. Or so say its
detractors, and they have a point. Or five.
While it's
not immutable - as gold is - the Dow Jones index still changes little,
despite the changing fortunes of America's biggest stocks. The Dow also
includes only 30 out of the thousands of listed stocks traded on US
exchanges, and 30 hand-picked stocks at that, chosen by a committee with few
hard rules. Nor does the index weight those 30 stocks by their size in the
market. Instead, it adds
up their share prices, and then divides by a "Dow divisor", an
arbitrary number (currently 0.132129493
begin_of_the_skype_highlighting GRATUIT
0.132129493 end_of_the_skype_highlighting
according to the Wall Street Journal) which itself has to be changed
any time there's a stock split or switch in the membership. That means that
highly-priced stocks have more impact than lower-priced stock in much bigger
companies.
So as a guide
to corporate America, the DJIA falls short. But are broader indices -
weighted by market capitalization - any better?
Not much to
choose between the DJIA and the more inclusive, more rigorous S&P 500
index then. Not when they're used to judge equity investing against buying gold. Indeed,
the Dow has performed less badly against gold since its all-time top than the
broader index has. One ounce of gold now buys 5.1 times as much Dow index has
it did in mid-2000, ignoring transaction costs (first into cash and then into
stocks). But it buys 6.4 times as much of the S&P 500.
The Dow/Gold
Ratio thus captures in a very broad way how badly money invested in
productive, go-getting America has fared versus the ultimate lump of
do-nothing, get-nothing-but-avoid-absolute-loss stuff. Gold has clearly been
the perfect place to bury your savings as the returns to equity capital have
been overwhelmed by the risks. That's also made the Dow/Gold Ratio the
perfect long-term indicator for über-bearish
equity bears.
"I would
expect this out-performance [by gold] to continue for the next few years,"
said Swiss wealth manager and Asia-based author Marc Faber in
2005, five years after the Dow/Gold Ratio began its descent. In the end,
he forecast, "Gold holders will be able to buy one Dow Jones with just
one ounce of gold." But by early 2009, Faber had revised his opinion -
"One day the price of gold will be higher than the Dow Jones," he
told a Barron's
roundtable that January. That same 1:1 ratio - seen briefly in early 1980
as the Gold Price
peaked and US stocks headed towards what proved table-banging chance to buy
cheap - also appeals to fellow stock-market doomsayer Bob Janjuah
of Nomura (see Nov. 2011,
or March
or April
2012).
"The US
Dollar price of an ounce of gold and the Dow will, I believe, converge at or
around 1, at some point over the next 2 years or so. I have extremely high
conviction on this. What I am not sure on is whether we converge at 7000, or
at 14000."
Put another
way, the Dow could hold where it is, or halve in value. The gold price will be many
times higher either way on Janjuah's analysis. (We
can't find him daring to imagine parity might be lower. In that event, with
cash itself surging in value and driving the mother of all deflationary
depressions, owning gold at a price of say $1000 would likely appeal to very
many more people than trusting Dow 1,000.)
Now, you
might think appealing to the Dow/Gold Ratio for an equity forecast pretty
lame. Especially if you appeal to the ratio's all-time record bottom as if
some iron law of history says that the early 1980s' low must be revisited
before the bear market in stocks is done. It didn't even get there during the
Great Depression!
What's more,
mean reversion would suggest gold is already over-priced and stocks are
cheap, with both the Dow/Gold and S&P/Gold Ratios now sitting at just 50%
of their half-century averages. So less apocalyptic analysts might pick a
less dramatic extreme turning point (as this
one did in February 2009). Less aggressive investors might also want to avoid
trying to nail the very lowest low, making do with the 6-fold rise in gold's
equity value already seen since 2000.
Thing is,
there would be another 6-fold rise on the table if the Dow/Gold Ratio did
fall to 1.0 - and even if, buying early ahead of the ultimate cataclysm in
stocks, you missed the bullet of failed corporations (the New York Stock
Exchange contracted by 1-in-14 listed equities during 1929-1933, and by
1-in-28 during 1978-1982), then the unlisted brokerages holding your stocks
for you would still be sure to struggle as the equity market sank. Buying gold gets you
off-risk for anyone else's financial failure, giving you price-risk alone and
free from the danger of absolute loss.
That's what
drove the Dollar gold
price per ounce to parity with the Dow in 1932 and 1980. If the world's
relentless banking crisis pushes it there again, having the guts to make the
switch from preservation to equity-risk will be a rare thing indeed.
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