My Interpretation of the Dow to Gold Ratio – Why Stocks Have More Downside and Why Gold Has More Upside
Stocks rebounded again last week as metals retreated slightly.
The Dow to Gold ratio now stands at 17.78. For those of you unfamiliar with the Dow to Gold ratio indicator, it is calculated by taking the price of the Dow Jones Industrial Average and dividing by the price of gold per ounce.
The Dow began the week at 26,797.46 while gold was at 1507.50. That makes the Dow to gold ratio 17.78 (26,797.46/1507.50)
My long-term forecast continues to be that this ratio will reach 1 which means more downside for stocks and more upside for gold.
Given the current level of 17.78, that last sentence may be an understatement.
The reality is that in order to hit that target of 1, stocks will have to significantly fall, and gold will need to rally strongly.
In my view, economic circumstances that exist around the world presently suggest that is a likely outcome.
As crazy as that prediction might sound to you, her me out.
To begin with, much of the rally in stocks over the past couple of years has been due to stock buybacks of their own stock by companies.
This from CNN on August 22 (https://www.cnn.com/2019/08/22/investing/stock-buybacks-drop-tax-cuts/index.html):
Corporate America’s epic buyback mania may finally be succumbing to gravity.
The 2017 corporate tax cut left US businesses flush with cash. S&P 500 companies responded by rewarding shareholders with record amounts of buybacks in 2018, with each quarter setting an all-time high.
However, that record-shattering pace appears to be slowing. S&P 500 companies executed $165.7 billion of buybacks during the second quarter of 2019, according to preliminary estimates by S&P Dow Jones Indices. Although that’s still a stunning amount of repurchases, it marks a 13% decline from the same period a year ago.
The slowdown in buybacks, which have become a lightning rod for criticism among some in Washington and even on Wall Street, underlines the impact the tax law had last year as companies steered a sizable chunk of their windfall to investors.
As stock buybacks slow, one of the activities that has been supporting the stock market becomes less supportive making stocks more susceptible to a decline.
Secondly, margin debt is higher month-over-month. Margin debt is debt that an investor incurs to purchase securities, usually stocks. As long as margin debt keeps rising, it helps create more demand for stocks.
While margin debt is near an all-time high on a nominal basis, on a real basis, adjusted for inflation, margin debt is still below all-time highs. Perhaps there is a little more room to add to margin debt, but I wouldn’t count on it.
Thirdly, one of Warren Buffet’s favorite indicators to gauge stock valuation, market capitalization to Gross Domestic Product is inflated.
The chart printed here illustrates market capitalization to GDP. Note that the ratio remains slightly below the levels prior to the tech stock crash but is much higher than just prior to the financial crisis about one decade ago.
Finally, “Fortune” magazine had this to say recently about stocks (Source: https://fortune.com/2019/07/31/yes-stocks-are-overvalued-but-by-how-much-heres-what-history-tells-us/) (emphasis added):
Robert Shiller’s cyclically-adjusted price-to-earnings (CAPE) ratio has only breached 30 three times in history.
The first time was in 1929, just a few short months before the stock market was trounced in one of the worst crashes in history during the Great Depression. Almost 70 years later, it happened again in 1997 and stayed above that level for nearly 5 years as the dot-com bubble deflated. The most recent flirtation with a CAPE of 30 began in the summer of 2017, where it has remained in a tight range ever since.
This chart, printed with the article, illustrates.
As far as gold is concerned, central bank policies are improving the fundamentals for gold.
Money creation via quantitative easing programs worldwide are bullish for tangible assets, gold in particular.
Peter Schiff, past guest on RLA Radio, had this to say this past week about his call for gold reaching $5,000 per ounce this past week (Source: https://kingworldnews.com/peter-schiff-on-his-5000-gold-call-and-todays-pullback-in-gold-silver/):
Most investors think my $5,000 gold call is crazy. But what’s crazier negative interest rates or $5,000 gold? In the insane world of negative interest rates, $5,000 gold is the one thing that makes sense. In fact, $5,000 for an ounce of gold will likely prove to be a bargain!
This week’s guest on Retirement Lifestyle Advocate’s Radio, Mr. Michael Pento of Pento Portfolio Strategies had this to say about gold.
He explained that when interest rates are up, keeping money in cash in a deposit account makes sense.
Given a choice between depositing money in a deposit account yielding 6% interest or buying gold that yields 0, mot investors will choose the deposit account and capture the investment yield.
On the other hand, if both cash accounts and gold are yielding zero, most investors would opt for the tangible asset, gold rather than keeping assets in a fiat currency.
Today, however, for many investors the choice is even more obvious. Given a choice between gold and a negative-yielding cash account, the gold becomes a ‘no-brainer’.
As central banks continue to pursue crazy monetary policies like negative interest rates, that will likely be bullish for gold.
The entire radio program and the interview with Michael Pento are now posted at www.RetirementLifestyleAdvocates.com.