Another extremely volatile week for stocks. The fact that stocks finished up for the week doesn’t tell much of the story.
Take the Dow Jones Industrial Average as an example. While it opened the week at 25,409.36 and closed the week at 25,864.78, during the week it touched 27,051 and 25,302. That’s a swing of about 7% within the confines of 5 trading days.
The stock market volatility saw many investors moving for other assets. US Treasuries rallied monstrously. The 30-Year US Treasury’s yield now stands at 1.25%. Gold and silver also benefitted from stock’s volatility. Gold rallied 5.53% and silver followed closely, gaining 4.81%.
The events that I have been writing about for a long time may be coming to pass. As I have often stated, central bank easy money policies lead to prosperity illusions that historically speaking, ALWAYS end badly. Put another way, you can’t print your way to prosperity.
I’ve long predicted a Dow to Gold ratio of 2, but more likely 1 (as unfathomable as that may sound). In December of last year, that ratio stood at about 20, it is now approaching 15, that’s a move of 25% in a few, short months.
For those of you who are not familiar with the Dow to Gold ratio and why I like to use it, in light of the volatility in the markets, I thought it would be helpful for all of my readers if I explained in greater detail.
The Dow to Gold ratio is calculated by taking the value of the Dow Jones Industrial Average in US Dollars and dividing that by the cost of gold per ounce in US Dollars. As the markets closed last Friday, the Dow stood at 25,864.78 and gold was selling for 1673.10 per ounce.
Here’s the trouble with measuring things in US Dollars; their value isn’t constant. Over time, because of the easy money policies referenced above, US Dollars lose purchasing power. As purchasing power is lost, costs and values rise. At least they rise nominally speaking.
For example, on January 1, 2000 the Dow Jones Industrial Average stood at 16,717. Comparing that to the value of the Dow today, one concludes that the Dow has increased about 55% over the last 20 years.
But that increase is in NOMINAL terms, not real terms. Since calendar year 2000, the US Dollar has lost a significant amount of purchasing power. Let’s look at just a couple of items.
In calendar year 2000, a base model Ford Mustang Coupe retailed for $17,190. Today, 20 years later, it retails for $26,670. That’s an increase of 55%.
How about looking at the price of hamburger?
In calendar year 2020, according to the website beef2live.com, a pound of hamburger cost $1.48. Today, according to the Bureau of Labor statistics, a pound of hamburger averages about $3.69. That’s an increase of 149%.
I would argue that these increases are largely a result of the devaluation of the US Dollar.
It’s this devaluation of the currency that makes measuring economic output and stock performance difficult. The reality is that when it comes to stock performance, nominal returns don’t matter, it’s real returns that you can feel in your pocketbook.
To make the point, let’s take a look at gold prices over the same 20-year time frame. In calendar year 2000, gold prices stood at $272 per ounce.
A Ford Mustang could have been purchased with 63 ounces of gold. Today, the same base model coupe version of the popular car could be obtained for about 16 ounces of gold.
In calendar year 2000, an ounce of gold purchased about 184 pounds of hamburger. Today, that same ounce of gold buys 454 pounds of hamburger.
Since an ounce of gold never changes (unlike US Dollars), it’s a better metric to use when determining real prices.
What about stocks?
There are many sources that graph the Dow to Gold ratio. In 2000, an investor could buy the entire Dow for about 40 ounces of gold, while today it only takes 15 ounces.
Here’s the very important point.
Measured in terms of US Dollars, asset values and consumer prices have been rising. Measured in real terms, they have been declining.
The same point could be made about economic output typically measured by Gross Domestic Product.
In calendar year 2000, the economic output of the United States as measured by Gross Domestic Product was $10.3 trillion. In 2019, economic output was $21.4 trillion. In nominal terms, that’s an increase of 107%. Impressive right?
Not so fast.
Let’s look at it in real terms.
In 2000 economic output measured in ounces of gold was about 37.9 billion gold ounces.
Last year, taking the low price of gold for the year of about $1270 per ounce, US economic output measured in ounces of gold was 16.85 billion gold ounces.
Money creation creates prosperity illusions. And, lest some of you readers think this is a political rant, it’s not. I am using a 20-year time frame very intentionally.
In real terms, we are in a deflationary environment. In nominal terms we are in an inflationary environment. What that means is storing some of your wealth in tangible assets over the past two decades has increased the purchasing power of that stored wealth. Storing your wealth in paper assets has seen purchasing power decline.
Given my forecast for the Dow to Gold ratio to reach 2 or even 1, I expect this trend to continue and intensify over the long term.
The Fed will do what they can to fight back. This past week, the Fed cut interest rates by .5%. The yield on the 30-Year US Treasury Bond now stands at 1.25% an all-time low.
Can interest rates go lower?
I think so, although an increase in interest rates from these lows given last week’s extreme price activity seems likely. If you own long term US Treasuries, you might even consider taking some profits here and buy a dip in bond prices moving ahead. (Note: this can be confusing since bond prices and yields move in opposite directions. When yields fall, prices rise and vice versa.)
Before the election later this year, I would not be surprised to see negative interest rates on some US Treasury issues and perhaps even helicopter money from the politicians.
Helicopter money is money that is created and given directly to citizens rather than banks as in the case with quantitative easing. Helicopter money could come in the form of a tax cut that is advanced to taxpayers.
While free money might sound nice on the surface, it’s ultimately very destructive.
Should these two events, helicopter money and negative interest rates occur, you’ll want to be tangible with more of your assets. Gold, silver and some kinds of real estate may be attractive for many investors moving ahead.
If you have not yet adopted the ‘two bucket’ approach to managing money, I would urge you to strongly consider. It’s my strong conviction that using the traditional ‘one bucket’ approach used by “Wall Street Only” financial professionals will fail many investors in the near future.
I saw first-hand the devastation it wrought with many aspiring retirees in 2007-2008 and before that in 2000-2002. When this bubble bursts, it has the potential to be far worse.