Fascinating chart from David Singer; I am still struggling to decipher just what it means.
The Bar Chart is the ratio of Dow Industrials to Gold; it asks, how much Dow does an ounce of Gold buy? The line on the chart is the Dow.
It makes some sense that there is a parallel between Gold and the Dow, given the impact of inflation and geopolitical risks on both.
The divergence since 2003 — when interest rates were slashed to generational lows, and the War in Iraq began.
If anyone has another theory or explanation, I am all ears . . .
The post ’03/911 world is also the one when US growth slowed long-term, the world developed ‘excess’ liquidity for multiple reasons and the level of geo-political risks (especially oil) became clearer. Prior to ’03 it looks to me as if gold and the Dow were responding as highly correlated asset classes. Post ’03 it looks liquidities, ala Gross, et.al., is driving the Dow up while risks are shifting the relative prices of stocks vs. gold.
If that resonates with anyone then the questions that should be asked are so what and what next ? In other words why are risk premiums so low – did they just get bid away and is risks badly, badly, badly mispriced ? And is so will the re-pricing of risk that should have occurred in sub-prime work it’s way thru other assets classes ?
Fascinating chart. Please thank Mr. Singer. Would love to hear his comments and reactions to the risk vs liquidities vs re-pricing issues.
Is there a longer range available…the primary driver of this chart could simply be the current bull in gold. Prior to 2003, gold was drifting so it follows the Dow…once it got its legs, it diverges, but what do prior slices look like during prior gold bull markets?
BR don’t forget to account for the massive spending on the Rx plan for seniors.
It is the first sign of a multilateral plan to challenge the dollar hegemony and the US world supremacy. In preparation for a simultaneous surprise dumping of dollar debt by China, India, Russia and the Saudis.
These new “allies” want to reshape the UN security council and teach the world’s only superpower some humility. The financial crisis caused by the dollar collapse will hurt all, but those with more natural resources and commodities will come out the relative winners.
Ok, here is my question…
Let say there is a correction and the dollar tanks. (this will create a mess in the world economy) Assume it cuts to about half its value relative to other currencies…
Where does one invest to protect funds both in liquid cash and longer term retirement holdings? I’m just a little guy, not some savvy wall street investor.
I see four possible options…
Raw Land? (for liquid cash)
Raw gold/silver? (for liquid cash)
Gold funds? (for retirement funds)
International? (for retirement funds)
Suggestions?
Thanks
Interesting. How does this chart look around other “dynamic” geopolitical times that the US was squarely involved in (i.e. Gulf War, Iran-Contra)?
Its hard to determine a “trend” given only one data point – this Iraq war.
I remember reading about this type of ratio last year at the Optimist:
http://sitekreator.com/Optimist/deflat.html
or here
http://www.gold-eagle.com/editorials_05/optimist041406.html
His/her take is that the value of the Dow (and other things) is actually in “deflation” when measured by ounces of gold. That the deflation scare of a couple years ago was real and what you are seeing is rampant inflation in asset prices as the Fed combats the deflation in value measured by a non-inflating currency (i.e., gold).
Offhand, how about an increase in purchasing power among people who like shiny yellow metal things more than they like the 30 stocks in the dow. Indians and Chinese come to mind.
Some differences that I see–
The bear market in gold beginning in the 1980’s corresponds with the fall of the Sovet Union and falls under the general heading of ‘peace dividend’. No correlation with markets until the inverse correlation corresponding with both the above and the constant fall of interest rates in the 90’s – themselves related.
The current correlation between the two corresponds to the correlation that exists between almost all speculative investments during the present liquidity orgy and has no more meaning than the price of zinc. Did gold participate in whatever ‘flight to quality’ occurred two weeks ago? Hardly.
Draw the same chart removing the not-soon-to-be-repeated anomaly of the tech boom/bust – say mid-97 to mid-03 – and see what you get. (No promises here, but it’s almost always an interesting exercise).
BTW, the chart is really “how much gold does the dow buy” and the correlations are actually reversed. And why do people continue to use the Dow for anything? From late 99 to August 06 it had configured itself as self-hedging and doesn’t well represent its asset class.
Hi Barry. Here’s my humble response, my take.
It means that the value of the Dow has gone up when priced in dollars, but down when priced in gold. It’s a currency question, implying that the market rally is just US dollar inflation. What the divergence is saying is that the price of gold is going up and the price of dollars is going down. We get lazy and forget that whenever you look at a “regular” chart of the Dow, it compares two variables: Dow and U.S. dollars.
Chart the Dow in dollars and we have a multi-year rally.
Chart the Dow in euros and we’re pretty much flat.
Chart the Dow in gold and we’ve been falling for a while now.
The chart implies then that the US stock market rally is an illusion, we just *think* the markets are going up, but really it’s just the currency going down.
Use gold as your money, and the price of oil is pretty much unchanged over the same period.
(Which makes you think that it might not have been dumb to have based Iraq’s new currency on the shiny stuff.)
Another way of thinking it is:
The price of dollars in gold terms has been falling dramatically. The price of euros has been falling more slowly. Some people think gold is the world’s measuring stick and use anecdotes, like that and ounce of gold bought a man’s suit in the 19th century, and it buys you a decent suit today. I think that’s not the best comparison, but you get the point.
I like to remind myself that when I go to Trader Joe’s, I SELL them my dollars for which they PAY me in food and wine.
Sounds strange, but turn a Dow chart upside down and you’ve got the a chart of US dollars priced in Dow.
One could say that if gold is the benchmark, all floating currencies are falling precipitously. Money supply growth is hailed as the culprit so often.
You hear traders saying, “There’s just so much LIQUIDITY out there!”
What the hell does that mean? Does it mean inflation?
Inflation in what? The price of processors falls, of clothing falls, but the price of college and health care goes up. Way up.
Technology and globalization push the price of many material goods down faster than the price of US dollars goes down (also faster than the price of Japanese yen goes down even when they’re giving it away… another source of this “liquidity”). But the price of college, a service, rises in US dollar terms.
I’d love to see a multi-year chart of services like college tuition and health care priced in gold.
That said, I personally don’t think anything is a stable benchmark, but instead that all prices are pretty relative.
Inflation to me means growth in the money supply that outpaces growth of wealth. Now in a globalized situation, this gets complicated doesn’t it, with competing floating currencies.
Here’s an interesting related article, and op/ed piece in the FT.
http://www.ft.com/cms/s/518a0102-9c61-11db-9c9b-0000779e2340.html
Ooops, please excuse the redundancies at the beginning of my comments above.
it’d be interesting to see a gold/yen chart too.
they’ve been printing money like no tomorrow, and had *deflation* not inflation.
in a deflationary scenario, shouldn’t the price of gold fall vis-a-vis the yen?
“in a deflationary scenario, shouldn’t the price of gold fall vis-a-vis the yen?”
Not this time. Their “deflation” means falling prices, but not a falling supply of yen or yen-based credit. They’ve had rapid monetary expansion, leading to a falling currency, so gold priced in yen has been rising faster than gold priced in USD. More yen seeking the same amount of everything else. The problem has been that the price of everything else has been falling as fast or sometimes faster than the price of yen. See?
Gold is
So, to continue quickly,
there *is* a difference between rising prices and monetary inflation, or falling prices and deflation.
Inflation just means inflating the money supply. That said, today there are many sources of money.
Japan has been inflating its currency. But prices in Japan have been stagnant because, well because things were just so expensive in Japan before and so the prices of material goods in Japan is falling as many inefficiencies are removed. For example in the past in Japan you would have paid way more for a dishwasher whether you paid in yen, dollars or gold. Now their local prices have been coming into line with other countries’ prices. So the *price* of things has been going down, which makes for a tough business environment at the same time, so they’ve been happy to *inflate* the money supply and offer basement-bargain interest rates. Like 0% interest for a while. So how can you have deflation plus an increasing money supply. No, they’ve had falling prices *despite* inflation, despite a rapid growth in the amount of yen.
Shouldn’t the post be titled Dow/Gold Ratio? Threw me for a second until I read the fine print on the graph.
Day4night,
You raise an interesting question for those who follow the classical theory that defines inflation as an expansion of money supply. But massive money supply expansion had no quick impact on ending deflation in Japan. Why?
http://www.sharelynx.com/chartsfixed/600yeargold.gif
Strange commodity is gold
Any purchase of gold made at the time of the religious war in Europe (XV century)will not have seen this price ever and would have been close to it in 1998 only.
Gold price was close to its low during the Napolenic period, close to its low during WW1 and the great depression.
There is an inverse relationship between gold and the dow and it is a poor investment in the long term.
Mr Greenspan made a dissertation on the merit of holding gold in the years 1980
If Gold is the denominator, as suggested by the ratio, then Gold has been rising faster than the Dow.
Quick answer to the higher velocity of Gold:
People in China and India feeling some prosperities and want some bling-bling.
I’d agree: China and India have a long tradition of owning gold… so do Middle Eastern oil areas.
One test would be: add in the volume (ie: total constant dollars or other adjusted measure) to see whether the total wealth in gold – not just the price per oz – has gone up or down over the years.
“Day4night,
You raise an interesting question for those who follow the classical theory that defines inflation as an expansion of money supply. But massive money supply expansion had no quick impact on ending deflation in Japan. Why?”
Jeremy, that’s a good question, and I think there are several possible reasons:
1) Domestic prices fell faster than the price of yen fell. How?
I remember being on a US Air Force base in northern Japan (I used to fly w/Navy intel planes), and they had a huge black market problem because goods at the PX were so much cheaper than comparable goods outside the gates. You could but a dryer at the PX and go and sell it for twice the price to your new Japanese friends.
Industrial policy was set up in a way that kept prices high, I guess you could say.
Now they import more. They’ve deregulated a lot. And, in a word, China.
I also remember when discount stores first hit Japan. The whole notion of paying less was new! At the same time, you’ve had deregulation of markets and the undoing of the famous Japanese “distribution” system. I’m not sure but I bet that today when you buy gasoline in Japan a team of roller-skating attendants don’t buff and shine your car, check the oil and pump your gas like they used to.
Food was crazy expensive! Now there are headlines like this: “Tokyo food prices lower than in New York, Paris” — Japan Today.
2) Business wasn’t growing, unemployment was rising, demographic difficulties meant fewer workers as a proportion of the economy.
(Watch Japanese women, not because they’re cute–you perv!–but because if they enter the working force for real you could *then* see real economic growth in Japan I think.)
3) A significant amount of the growth in money went out of the country, chasing return in “samurai bonds” and so on. Maybe a temporary thing.
4) Like everywhere else, productivity growth through technology.
Remember, prices in the States have also remained tame despite rapid monetary expansion.
These are just some stabs at an answer….
“The chart implies then that the US stock market rally is an illusion, we just *think* the markets are going up, but really it’s just the currency going down.”
Thanks for my “Bingo” moment of the day4night
The chart is the Dow price of gold.
It could be compared to the dollar price of gold, Euro price of gold, yen price of gold, etc.
Or, to the Dow price of the dollar, Dow price of the Euro, Dow price of yen, etc.
Or, to the Egg McMuffin price of gold.
Or, to the Dow price of a McMuffin.
All of which are equally useful.
Here, a case is made for the Dow/Gold ratio as a proxy for Tobin’s Q.
http://www.sharelynx.com/chartstemp/DJAUTobinsQAH.php
“Here, a case is made for the Dow/Gold ratio as a proxy for Tobin’s Q.”
Not familiar with this. Can you explain roughly how its intuitive?
Thanks.
This chart is needlessly complex. A chart of Dow/Gold is different from a chart of Dow, only when Gold prices change. You get the same result by plotting the price of Gold. BTW, last time this happened: 1979.
Hussman has some interesting points about gold and gold stocks:
http://www.hussmanfunds.com/html/gold.htm
US gov’t selling gold to buy stocks and index futures via several cutouts. It’s all on the internets.
I think the ratio means how many ounces of gold to buy one share of the Dow? (whenever D/G >1), the inverse of how many shares of the Dow an ounce of gold buys.
It’s pretty simple. If you focus on the secular trends, you make a lot of money in the market. The Dow/Gold chart is telling us that we are in an era of hard assets outperforming paper assets. When you throw in the nominal Dow, it shows you how much inflation we have in the system. Furthermore, look at a 110 year chart of the Dow/Gold….you will see that at the end of the bull markets in hard assets, that Gold has twice moved to the same value as the Dow and one time it was 50% of the Dow.
It shows us either how overvalued paper assets are to hard assets. Dow/Gold is currently 16. It’s headed to 10 in the next year and eventually 1 or 2.
BR,
Is this what you’re saying:
– the Dow/Gold ratio has a high correlation to the Tobin Q
– the current level of the Dow/Gold is around 1997 level, which corresponds to a Tobin Q of around 1.3 (just eyeballing)
– level above 1 implies Dow is still relatively more expensive (overvalued) than Gold, despite the run-up in Gold prices
Sam,
That is my interpretation (Tobin’s q as a measure of overvaluation). There’s more on Tobin’s q and some references to Steven Wright’s paper here:
http://www.smithers.co.uk/faqs.php
“we are in an era of hard assets outperforming paper assets”
Maybe, maybe not. You must consider inelasticity of gold supply and whether there is a special-purpose or one-time demand (such as, perhaps, “new” wealth in India). Gold is not a stand-in for all ‘hard’ assets.
Too much money chasing too few goods — classic inflation.
But…. there is no inflation, right?
Heh.
Jordan, exactly. You got it.
Mike
TM, you inquired about investments for hedging against a collapse in the US dollar. To be brief, take a look at EverBank.com . In particular, see their Currency Index CDs.
A comparison of assets is interesting – comparing platimum to gold over the same time period (by eyeballing two seperate charts) it appears that gold and platinum are parallel. If you then chart gold, platinum, and the Dow, turn the chart so that gold/platimum are flatlined, the Dow assumes an almost 90% angle, straight up.
When you look at the time frames, you see one overriding instigator and that is 1% interest rates with interest held too low far too long.
It seems no doubt that this bull market is built on debt, and will not unwind until some major player pulls the plug on funding the debt.
Thank you, Winston. Day4night touched on the elephant in the room, but most of the comments were focusing on the correlation rather than the divergence. The divergence is the key and it’s clearly tied to the change in credit cost and availability starting in 2003.
maybe it has to do with the scale of the graph (since larger numbers excelerate faster). At first glance I thought the time frame was much longer. Like one that shows the DJIA index way back to into the early 1900s.
It just has this continous uptrend and the big down turns don’t look as impressive the further back they occured in history of the market.
Basically current movements appear larger and more drastic in relation to previous occurances (which percentage wise would have been about equal).
Of course I know this bull market is just about dead.
I think that the divergence is due principally to the increase in the money supply both by the FED and the US Gov. starting in 1999 with the Y2k fears (Barry-you mentioned previously the extra $50 billion injected into the markets before Y2K as a safety measure previously). The responses–both the printing of more money and the lowering of interest rates, cutting taxes, etc. were tried and true responses to the recessionary effects of the Dot.com bust in 2000. The FED attempted to supply liquidity to ease market issues. 9/11 complicated this strategy and forced the FED to drive rates and increase the money supply even more because the attacks reduced consumer spending, the very engine the FED was attempting to keep from stalling.
At the same time, technological advances, namely the internet itself and the computing capicity exponentially increased, thus allowing corporations to export labor, increase productivity and use global assembly systems (Ford Escort was an early version of this as the world’s first “world car”). Thus, while the FED pumped money in, companies had fewer reasons to hire/ raise labor pay rates because of increased competition in international labor and dramatically higher rates of productivity.
The result was an explosion of credit and debt, followed by deflation in consumer goods’ pricing. In the end, prices at Target and Best Buy dropped (think about the LCD prices dropping now for a current version of the process), while homes, cars, gas and groceries rose in price.
With respect to the Dow, corporate profits exponentially increased because the margins–due to easy credit and increased labor competitino from abroad–drove down prices and increased profits.
Since all economic systems are entropic, the phenomenon of globalization brought labor into a world-wide freefall towards parity in labor prices. The result was that all of the economic stimulus that the FED had intended to add to the domestic economy actually ended up bankrolling the modernization of the BRIC countries, mostly the I and C, however–hence China’s trillion dollar $ reserves.
This created a virtuous cycle in which these reserved parked in Tbills maintained lower credit prices for a much longer period the FED intended, artificially extended the stimulus packages effects. The subprime meltdown is latest index of the diversification of these reserves and the end of the Ponzi scheme upon which it is based.
Thus, the divergence noted between the Dow and AU is a product of the extended play of the FED’s attempt to reinflate the economy. The mixed signals that we get–simultaneous oscillations between inflation and deflationary pressures–is apropos of a system trying to reground itself in a model of classic supply and demand. Volitility is increases because someone is taking cash out of the cycle–both China and the FED.
AU has increased in value as the canary in the cole mine of an impending credit crunch.
Yea like day4night said, you are seing the effect of three variables,
– the Dow gained value (in $) due to increased earning etc etc
– at the same time the US dollar lost purchasing power relative to other currencies and hard assets like gold
– finally gold started a bull market driven mostly by supply-demand dynamics like most other commodities. Gold was in a secular bear market for about the same 20 years that the stock market was in a bull.
So it’s only a matter of point of vue. The Dow appreciated when priced in USD, stayed flat when priced in Euros and lost some value when priced in Gold (which many believe is like another currency).
Makes you wonder what’s WallSt was all excited about when Dow hit 12000 last year. I guess they love these big ROUND deflating numbers…
TM,
Regarding where to store our wealth:
We see two things that will definitely change drastically in the near future
1. Volatility – Two weeks ago was just a hint, but what we are due to see is much more activity, which in turn will generate… even greater activity. This will happen mostly due to a…
2. Credit Crunch – We are seeing this currently in the sub-prime lenders everyone’s raving about, but the true problem lies much deeper. History tells us that after a system is flush with liquidity – where all assets rise and everyone makes money – the system then “gets flushed” and money, in simple layman’s terms, disappears.
Thus, the value of a dollar (and your entire retirement portfolio along with it) may change day in and day out. A measure of commodities on the other hand will not change much. (100 bushels of wheat will feed you for the same amount of time).
So what I gather primarily from the chart is that we have to stop thinking in terms of dollars and more in ounces.
Gold isn’t worth much if you’re starving on a desert island. However it does evaluate fairly the measure of another commodity (be it physical or monetary). But hold real assets because financial issues are in for a ride.
The sentiment is mostly towards stocks and financial assets while many conceive commodities as “too risky”, but that will change – as it always has.
day4made
“Some people think gold is the world’s measuring stick and use anecdotes, like that and ounce of gold bought a man’s suit in the 19th century, and it buys you a decent suit today”. On the contrary, it’s the best analouge.
“There’s just so much LIQUIDITY out there!” It means that money was being printed faster than the supply for commodities has been able to keep up.
You made some great points. If you’re trying to show how a dollar loses money then look no further than the history of the dollar itself and its predececors. Continentals and Greenbacks are long gone and our dollar which was once worth an ounce of silver, will now buy you about Four 1913-cents.
You also mention in later posts about the fact that prices have been stable while the supply of money has increased. This is another symptom of a credit surpluss. The price of bread won’t crash overnight but the price of a stock may. In other words money disappears, hard assets and items in a grocery don’t.
Philippe,
We are still in early stages of a Bull Market – Read : The change of sentiment from dollar-thinking to gold-thinking. Even fresh after the Bretton Woods Agreement, through years of a rising CPI, it still took Americans almost 10 years to catch on.
I’m no Technical analyst, but see how fast the price of gold gapped down in the late 1500s and then up again in late 1900s? This rise in gold may be larger than we think. (Just a Thought). My price for gold is reasonably around $12,000 or 1:1 to the Dow. Which ever comes first.
The first chart comparing Dow/$ and Dow/gold suggests some directional reconvergence of the two. This suggests either a decrease in Dow/$, or an increase in Dow/gold, or both.
At the same time, the second chart (comments) on the correlation of Tobin’s Q with Dow/gold, and its positioning relative to a Q of 1, suggest a further decrease in Dow/gold.
The two charts together therefore suggest a decrease in Dow/$ as the source of reconvergence.
At some point, a Dow/$ decline might reconverge with the Dow/gold level. But given the scale used in the chart, this would seem almost impossible to achieve unless the decrease in Dow/$ is accompanied by a decrease in gold/$. Eyeballing the chart scales, the following are approximate possibilities for cross over:
Dow 10,000, Gold 300, Dow/Gold 33, Tobin Q 2.0
Dow 6,000, Gold 300, Dow/Gold 20, Tobin Q 1.4
Dow 3,000, Gold 300, Dow/Gold 10, Tobin Q .8
The chart as scaled would not allow for both meaningful increases in gold/$ (e.g. to $ 1,000) and reconvergence of Dow/$ with Dow/gold (e.g. unless Dow/$ fell to $ 1,000 or below).
Scale is everything.
I’ll say it again: all you are comparing here is price. Think about it.
BR
In forecasting, it is always useful to contemplate whether these relationships are random or whether there is some path-dependency – else one goes down the road of “magical thought” in drawing conclusions.
It is – as a number of your readers have pointed out – simple relative price. But context is everything. The demolition of “things tangible” in the late 90’s and early milennium – the same phenomena that wiped out Sumitomo’s Hamanaka, Codelco’s Juan-Pablo Davila, in Copper and Metallgeselschaft in Oil – was part of a multi-year divergence of such “things”, with Gold but a telltale. But make no mistake, they are “tethered” if at times only loosely, for shares are an asset with the lion’s share of aggregate total return made up by an inflation component of the same variety that bids up prices of other things tangible. The current re-alignment trend evidenced by the chart says less that nominal equity prices are too high (for nominal earnings have more or less kept pace, and alternative yield opps remained tame), than asset prices are (or at least were) – relatively speaking – too low.
Historically, interest rates acted as the adjustment relief-valve, gyrating up or down, thereby providing equity markets and commodity markets with proper price signals, though sadly, with Official CB intervention, the bond-market has had its manhood placed in a lock-box, allowing greater nominal asset price growth without (for the moment) associated goods-price inflation or back-up in yields. Presently, Gold is merely reflecting what markets already know: US Fiscal and Monetary policy is, and has been, “well behind the curve”, something the bond market might tell us if only the PBoC, BoJ, & GCC enablers would remove the duct tape from USD bond market’s mouth…
“If anyone has another theory or explanation, I am all ears . . .”
The cycle of hard and soft assets:
http://www.nowandfutures.com/images/dow_gold_oil_crb1900-current.png
It is easy to forget when we talk of money creation that by definition we are talking about debt – that is then multipled by fractional reserve banking and the multiplication of that debt. That debt must be serviced, and so far FCBs have been happy to do so, as their need is to hold dollars; however, if the Euro were to replace the dollar as the interntional exchange currency, especially in oil, the subsequent dumping of dollars onto the exchanges would drive down the dollar, and force bonds and interest rates higher.
The only upward limit to currency/debt creation is in the willingness to service the debt; gold, however, has limited supply and is subject to the law of supply and demand.
It really doesn’t matter which asset class you are holding until the dam bursts, and there is no way to know when that will be.
F what John Hussman defines in his Monday piece is the notion of Liquidity, even J6P’s like myself get it and cant help doing the “chicken-dance” in-front of the idiot box while caluclating “real” savings for the next 50 months on the 651 basis points I am earning by paying off my car loan this week :)
Nice added bonus noting my insurance-cost will be lower as a result!