The Dow to Gold Ratio

I am not a big chart person, but they can still be useful for reference and some historical perspective.  One interesting chart is the Dow-to-gold ratio.  It tells us how many ounces of gold it takes to buy the Dow Jones Industrial Average.

For example, if the gold price is $1,000 and the Dow is trading at 16,000, then the Dow-to-gold ratio is 16.  It would take 16 ounces of gold to buy the Dow index.

The current ratio is between 13 and 14.  It has gone down from over 16 in late 2015.  This is a result of a higher gold price and lower stock prices.

The ratio actually went over 42 back in 1999.  This is when gold was trading for under $300 per ounce.

On the other hand, the ratio briefly went close to one back in late 1979 and early 1980.  This was when gold briefly went over $800 per ounce before crashing down.  This was the biggest bubble in gold in American history.  The bubble popped after Paul Volcker, then chairman of the Fed, adopted the appropriate policy of stopping the monetary inflation and letting interest rates go higher.  This saved the dollar.

Again, there is nothing magical about the Dow-to-gold ratio, just as there is nothing magical about the gold-to-silver ratio.  There is nothing to say that it can’t break a certain range.  It is even less accurate using the Dow as a measure because of the change in the 30 stocks that make up the index.

It is just interesting to note how wide the variances are.  It is hard to believe that in 1979/ 1980, you could nearly buy the whole Dow index with one ounce of gold.  Then, 20 years later, it would take you 40 ounces of gold to buy the same Dow index.

Just think what it would take for the Dow-to-gold ratio to get back to one.  If the Dow fell by over 50% to 8,000, then gold would still have to go up by more than 6 times its current price.  A lot will have changed if we see the Dow at 8,000 and gold at $8,000 per ounce.

As of right now, we seem to be in an economic downturn.  This makes sense due to the tight monetary policy of the Fed since QE3 ended in October 2014.  While interest rates have remained low, the Fed has stabilized the monetary base for well over a year.  As long as we have a Fed, this is the right policy.  The problem is the massive monetary inflation from 2008 to 2014.  All of the misallocated resources from this loose monetary policy mean we will have a correction at some point.  The only question is whether we are near that full correction.  We have already seen it in the oil market.

Gold has done well in the last two months in the face of a falling stock market.  I believe investors are looking for positive yield.  With interest rates near zero – or even negative in some countries – it makes sense that at least a few investors would be looking at other asset classes.

The only way we will see anything close to a 1 to 1 ratio for the Dow to gold is if the Fed starts inflating again.  This is certainly a good possibility if the economy shows further signs of weakness, including falling stocks.

We should not hope for a 1 to 1 ratio.  This would mean some form of economic chaos.  We really don’t want a repeat of 1979/ 1980.  We should only want a repeat of the Fed’s response, which was to maintain a tight monetary policy, despite recession.

Still, what we want is not the same as what we should prepare for.  We should know that a Dow-to-gold ratio of 1 is a possibility, even if it seems remote at this time.

If we ever do get anything close to that, I hope I am smart enough to sell some of my gold to buy stocks.  If someone had done that in early 1980, they would have made out very well.

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