Friday, January 12, 2007

Gold and the Dow

The Dow-to-gold ratio hit a high in favor of the Dow in July of 1999. At that time, one share of the Dow would buy 43.85 ounces of gold, an all-time record in favor of stocks or financials over gold or tangibles (real money). Since then the ratio has been declining in favor of gold. As of yesterday, the Dow/gold ratio had declined to 20.38, meaning that one share of the Dow would now buy only 20.38 ounces of gold, a decline of over 52% in the ratio from the 1999 high.

A critical question is how far this ratio in favor of gold might descend. In January 1980, at the height of the gold boom, the ratio sank to a record low of 1.04, meaning that the Dow would buy only one ounce of gold. I don't know whether we will ever again see a one-to-one ratio -- in which one share of the Dow will buy only one ounce of gold. But in this business, as you well know, anything can happen.

Ian Frazier, who writes the fine advisory, Deliberations out of Toronto (416.964.1359), presents the Dow/gold cycle in a fascinating way:

"Think of the Dow as a tradable ETF. In August, 1929, your grandfather sold one unit of the Dow and bought 18 1/2 ounces of gold. Three years later, when the Dow/gold ratio bottomed at 2:1, he sold those 18 ounces of gold and bought back 9 units of the Dow with the proceeds.

"Those 9 units reached another peak in 1966 when the ratio hit 28:1. Now your father exchanged those 9 Dow units for 252 ounces of gold. In January 1980, the ratio got to an almost unprecedented ratio of 1:1, so he converted those 252 ounces of gold into 252 units of the Dow.

"Come 1999 with the ratio at an unprecedented 43.85-to-1 level, the prudent family converted those 252 units of the Dow into 11,050 ounces of gold! No trades were based on the price of gold or the level of the Dow..... It's just a simple question of how many ounces of gold is the Dow trading for in the market.

"This little fictional fable started with 1 unit of the Dow at a peak in 1929. Two tops, two bottoms, and five trades later it's 11,050 ounces of gold in 70 years."


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