Dow Gold Ratio and The Silent US Stock Market Crash

In this article I would discuss about the dow gold ratio and if the dow gold ratio will touch 1 in the near term. With the help of the dow gold ratio I would also show how the US stock markets have crashed post 2000, even when it went up in dollar terms from 2003-2008.

In very simple words, the Dow Gold ratio tell investors how many ounces of gold is needed to buy one Dow Jones Industrial Index.

If we consider today's index value and gold prices then:

Dow Gold Ratio =Value of Dow Jones / Value of Gold in Ounce = 8409.93 / 906.20 = 9.28

So if the Dow Gold ratio has to touch one, either gold will go ballastic in the long term or the Dow Jones Index will crash very significantly. Below is my opinion on why I feel that Dow Gold ratio will touch one and why I also feel that it will be gold that will go ballastic in the long term leading to this ratio touching one.

Before I proceed, I woild like ot present a 200 year dow gold chart for readers. This will give a clear idea as to how this ratio has moved historically.

200 Years Dow/Gold Ratio: (Chart Source: www.sharelynx.com)

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• From the early 1930's to mid 1960's, the world witnessed more than three decades of bull market in paper assets. During this time the Dow/Gold ratio rose from a low of 2 up to a high of 28. It must be mentioned that during this period the gold prices were also fixed.
  

• Then there was a 15 year secular bull market in hard assets and its interesting to note that the dow gold ratio had reached very close to one during 1980. During 1980, Gold has peaked out at $850 an ounce and that had marked the end of a bull run for commodities and precious metals.

• Post 1980, the dow gold ratio kept on going up as it was a bear market for commodities and a bull market for equities. During 1999, the Dow Gold ratio had reached as high as 44. However, this trend reversed in the year 2000,post which the dow gold ratio is on a decline.

To make things more clear and to show how the US stock markets have declined since 2000, when measured in terms of a hard asset and also honest money like gold I would like to take the help of a second chart. This chart shows the movement of the Dow Jones compared to the movement of the Dow/Gold ratio.

Dow Jones Index vs Dow/Gold Ratio: (Chart Source: sharelynx.com)

• The Dow Jones Industrial Index and the Dow/Gold ratio moved almost together till the year 2003.

• Post 2003, the Dow/Gold ratio has declined. This means one needs lesser ounces of gold to buy one Dow Jones Index.

• What is interesting is that the stock markets have gone up post 2003 till late 2007. But during this period the dow gold ratio has gone down. This means that the stock markets have gone up only in nominal terms. In terms of real money or other hard assets the US stock market has been on a decline since 2000 as indicated by the Dow/Gold ratio.
  

Why did the divergence of Dow Jones and Dow/Gold Ratio Happen:

When the US stock market bubble went bust post 2000, the US Central Bank lowered interest rates drastically to 1%. The interest rates were near these lows for more then two years. In other words, the US central bank flooded the market with liquidity. So when there is ample paper money in the system the stock markets or any other asset class will go up. The same happened with Dow Jones and the index started to move up.

Analyst and other market participants called it another major bull run. But there was a silent crash taking place in the markets. The Dow/Gold ratio indicates that.

Since gold supply cannot be increased at will like paper money, the precious metal went up in value mainly due to the devaluation of the paper money. So everyone was fooled into believing that the US stocks are enjoying another bull run.

Interesting, in gold terms the US stock market is down near 70% from its peak during 2000. This is what I call the silent crash of the US markets.

Will the Dow/Gold Ratio Touch One:

I believe that in the long term the Dow/Gold ratio will touch one. This means visualizing a scenario where Dow Jones is at 5000 and gold is also at $5000 an ounce or maybe Dow Jones is much higher then 5000, but gold is also at the same levels.

In my opinion the Dow Jones will be much higher then 5000 and thus in my opinion Gold will go much above $5000 an ounce in the long run. The reasons are:

• Even if the Dow falls 15-20%, the US government will again step in and print some more money. This in turn will artifically support the market. However, the more number of dollars are printed the more it depreciates against hard assets and honest money like gold.

• So US will keep printing money for supporting the stock markets and all other asset classes and gold will keep going up.

• Moreover there is a high probability of US trying to inflate their way out of the huge debt burden they have.

So in my opinion a long term investor in US should have a good exposure to gold. This also holds true for investors in other parts of the world as all central banks have almost the same policies and these policies are inflationary in nature.