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Stocks Are Cheap, Gold Expensive

July 6, 2012 – May people take the Dow/gold ratio as an important indicator of the state of the economy. We are currently eight years behind a sinking of the Dow/gold ratio to its Great Depression low, and there is a renewed interest in looking at the ratio.

The Dow/gold ratio tracks how the Dow Jones Industrial Average performs in terms of the performance of gold instead of in terms of nominal dollars. The idea behind the ratio is to measure the performance of the dollar, the performance of gold, and the performance of the private sector in America.

In the corporate environment of 80 years ago, the Dow/gold ratio dipped to its lowest since 1900. The Dow held at just 41 points on July 8, 1932 with the gold price at $20.67 per troy ounce. Priced in gold, however, the US stock market dipped blow 2.0 with a drop of over 90 percent from the peak of only three and a half years prior, then hit its lowest level of the 20th century.

Though it isn’t unchangeable, as gold appear to be, the Dow Jones Industrial Average changes very little in spite of the stark changes in the fortunes of America’s biggest stocks. Also, the index only includes 30 out of thousands of stocks listed on US exchanges with the 30 being chosen by hand through a committee with few tough rules.

If you judge equity investing against buying gold, the Dow has performed less badly against gold since its all-time high. An ounce of gold currently buys 5.1 times as much Dow index compared with what it bought in mid-2000, without transaction costs.

The Dow/gold ratio can thus capture in a very broad way how money invested in the private sector of America compares with investments made in gold. Gold has outperformed the Dow, partially because returns to equities are very much overwhelmed by the risk in the markets.

“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. Faber also predicted a crossing of the Dow Jones and gold, which has not been seen since 1980 when the price of gold peaked and US stocks were bought very cheaply.

“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 two years or so. I have extremely high conviction on this. What I am not sure on is whether we converge at 7,000 or 14,000.”

The Dow could hold or it could halve in value but the gold price, accord to Bob Janjuah of Nomura, will be many times higher.

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