The Fabled Ratio

DJIA

open11,934.58

close 12,043.56 up 108.98

day high 12,098.81

day low 11,934.05

today's volume 177,920,112

3mo avg. daily volume 170,635,679

Average P/E  13.4

1 year change +18.73%

DJTA

open 5,219.23

close 5,259.19 up 45.04

day high 5,270.02

day low 5,196.86

today's volume 14,701,568

3mo avg. daily volume 16,872,528

Average P/E  20.0

1 year change +24.00%

The DOW/Gold Ratio has been talked to death (or life possibly in this case) for decades.  All foolish speculation aside, watching ratio's instead of prices give a much more relative and ultimately realistic view of how different markets react to each other.  People have talked ratio's for millennia, dating back in all cultures to the barter days before kings and kingdoms placing their faces and claiming authority through seigniorage.  Those same kingdoms have always tried to fool the public by shaving value from those mandatory coins either literally, or by devaluing them by using other less appealing products like copper, tin or paper, and most popular today, the 1's and 0's of binary in today's digital money.  But ratio's have held true, and those who ignore them are doomed to repeat the fools errands of those past.

When Charles Dow created his averages of the markets, they were based on a simple principle, the cumulative value of the average equals an ounce of gold... This ratio has stood the test of time as an indicator (at the very least) of over or undervaluation of the famed Dow Jones Industrial Average.  As rampant speculation through cheap leverage comes to a grinding halt, the averages have begun to realign themselves.  Although the grand US Dollar itself, incumbent placeholder as the true international reserve currency may be the cause for the diminishing role in industrial production and demand and a global cooling of speculation, as money exits investments and turns towards safety, the dollar, being the cause, is no longer the only place large scale investors are turning to.  Likely, as prices shift, one can assume the general investor will be soon to follow, although as usual, a day late and a very literal dollar short.

With a very legitimate, but elementary understanding of the DOW to Gold Ratio, one assumes that the most common way to track if the DOW to Gold Ratio is accurate is that when the DOW goes up, Gold goes down, and vice versa.  However, there are more scenario's the investor should be aware of, and although not perfectly cyclical, here is a look at how those could unfold.

 Scenario 1 shows a period I believe to be over at this point.  As example, see the two charts below showing the drop and rebound in the markets from 2008/2009 until today. The drop in the DOW from around 12,000 to 6,500 was roughly 45% fall.  Gold fell from around 1,050 to 700, a 33% fall.  See Scenario 2 above.  What is more telling is the recovery time.  The last time Gold reached a low price retrenchment that lined up with the old highs of 1,050 before the 2008/'2009 fall was October/November 2009, about exactly a year after it hit bottom.  Since then, gold has made an impressive $500 an ounce rise.  The DOW, on the other hand is, for the first time since, seeming to make that same claim as we speak, taking about 2 1/2 years to do so.  Despite the talking heads on TV, this is not recovery momentum.  This is clawing your way out of a fallen house.  Although I am no chartist, what the DOW appears to be doing is making a head-and-shoulders pattern which should signify downturn and should put the kibosh on those still determined to live in recovery fairy-tale land.

With the cause of the problem lying with the devaluation of the US Dollar, the likelihood that both sides of the ratio continue to rise, even at different levels should subside.  I would argue that we are currently seeing Scenario 2 and 3 play out, as the DOW long-term should remain level or slide down, the price of gold should increase over the same period of time.  During the Final manic phases of the Gold Bull Market, the DOW should have reached bargain prices causing wise investors to begin liquidating preservation positions like Gold and buying equities for pennies on the dollar.  Eventually, should the government choose to attempt to consolidate the value of our medium of exchange, making the assumption we still call it "the Dollar," our currency will find bottom values and interest rates rise.  At this time most of the wise investors will have sold their preservation positions off to those who are certain it is the right thing to do because everyone else around them seems to have figured it out already, and Gold will begin it's long decline as the equities markets begin to climb again and interest rates eventually seem reasonable.  Unfortunately for most, to find these bargains, the only way is to go against the flow or general consensus, which most will be incapable of bringing themselves to do.