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Minyan Mailbag: Got Gold?

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In secular bear market, gold still standard.

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Hello Prof. Lewis:

I saw your comments on Minyanville today regarding the Dow/Gold ratio, but I'm still not sure what the implications (if any) of such a low/crashing ratio would be.

Do you think it indicates any additional drops in the Dow? Or any additional increases in the price of gold?

Thanks in advance,
Minyan Anthony


Minyan Anthony:

While the Dow is in a bear market and will likely move lower over time (in the short term, I personally think some sort of bear market rally is probably overdue), most of the decline in the Dow/Gold ratio in the short term will probably be due to a dramatic spike in gold prices.

Either way, it's clear that gold has vastly outperformed stocks since 2000, and it continues to do so. When the Dow began to rise again in 2002, the secular bear market in stocks that started back in 2000 only appeared to end; in fact, it's been ongoing. That's because the gold-denominated Dow never reached new highs - only the dollar-denominated Dow did.

By looking at the ratio, we can determine that the continued "decline" in the value of stocks was merely masked by rising inflation (just as it was in the 1970s). Similarly, the current collapse in stocks is somewhat muted by rising inflation - without it, the Dow would be down even further than it is now.

Whether due to an outright price decline or because of adjustments for inflation, all secular bull markets in U.S. stocks have declined over 90% from their peak since 1900.

In the Depression of the 1930s, the dollar was fixed to gold, so you experienced true deflation, with the Dow losing over 90% on a nominal basis. In the 1970s, when the dollar's tie to gold was broken, the decline was also over 90% but occurred on an inflation-adjusted basis rather than a nominal one., as in the ratio below:


Click to enlarge


We will no doubt see a similar decline in stocks from their peak in 2000 during this secular bear market -- 90% or more -- but it will most likely occur primarily as a result of rising inflation, just as in the 1970s. Given the flat nature of the dollar and the fact that the system has become totally dependent on continued rapid money and credit creation, it simply couldn't function without it.

Now you see why I so often like to say: Got gold?

-Prof. Lewis
No positions in stocks mentioned.

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