Gold News

Dow-Gold Ratio

From the current Dow/Gold level to the all-time low looks absurd...

CHECK OUT THE CHART below from US Goldcorp, says Dan Denning in The Daily Reckoning Australia.

Remember, the world of government-issued paper not backed by gold has been expanding in ever-widening circles for the last 100 years. Now this chart shows precisely that phenomenon...a tide of paper money flowing into the world's real economy leading to bubbles.

And then the tide turns, leading to asset price crashes and soaring prices for precious metals such as Gold Bullion as the bad investments from the boom are liquidated.

The chart specifically shows the Dow vs. Gold Ratio going all the way back to the 19th century.

Think of this as the price of one Dow unit measured in ounces of gold.

What you can see is that large credit expansions lead to a high Dow/Gold Ratio. The value of stocks relative to gold soars as all the funny money in the economy translates into new corporate earnings and inflated expectations of future corporate earnings (i.e. much higher price/earnings ratios).

The disarming thing about this chart is that it doesn't look that far between a ratio of nine ounces to one and the very floor – hit in 1980 – of one to one. But oh, it is a long. A very long way.

One-to-one on the Dow/Gold Ratio means Dow 5,000 and gold $5,000 – or another one-third drop on Wall Street versus a quintupling and more of Gold Prices. Or how about Dow 6,000 for a lesser drop in stocks, but  gold up at $6,000 an ounce, more than 6.5 times its current level.

It's worth thinking about how the world would reach these extremes. Dow 4,000 and gold $4,000, for instance, would require a huge move for gold and a 50% crash in the Dow. We could see this happening with another capital crisis in the financial sector. But it's also possible that the Fed and other central banks can pursue unorthodox policy measures like purchasing stocks with freshly printed money. This would support stock markets nominally, although in inflation-adjusted terms it would be a bogus number.

Psychologically, however gold at $9,000 might not be as startling if the Dow were at say, 18,000. Yes, yes, that sounds absurd. But we live in an absurd world. People trade real goods which have tangible value for perfectly worthless pieces of paper. Anything is possible.

Best-selling author of The Bull Hunter (Wiley & Sons) and formerly analyzing equities and publishing investment ideas from Baltimore, Paris, London and then Melbourne, Dan Denning is now co-author of The Bill Bonner Letter from Bonner & Partners.

See our full archive of Dan Denning articles

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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