Wednesday, June 9, 2010

DOW:GOLD RATIO POISED FOR ANOTHER LEG DOWN

We've been following the Dow:gold ratio for quite a while. I've been saying for years that we will eventually see the ratio move to par by the time this bull is finished. Actually we may even see gold briefly become more expensive than stocks.


You can see from the above chart each swing since the 30's has been more extreme than the last on both the up and down side.

The extreme undervaluation of gold and overvaluation of stocks in 2000 will probably lead to an even larger swing down as the long term cycle moves back to the opposite extreme. I expect human emotions to work their magic and ultimately we will probably see gold briefly become more expensive than the industrials at a bubble top some time in the future.

At the moment the Dow:gold ratio may be poised for another leg down after the year and a half consolidation.


As you can see these big consolidations eventually lead to another leg down in the ratio. Once the consolidation completes we get another repricing of stocks compared to gold. Usually that means a big rally in gold although the last leg down included not only a big move higher in gold but also a drastic downward price adjustment in stocks. By the time stocks finished the bear market leg gold had established a new value zone between $1000 and the old 1980 high of $850. Then for almost a year and a half stocks rallied while gold consolidated that big move, eventually even broadening the range up to $1250.

Now gold is poised for another major leg up while stocks are stuck either in a consolidation of the big rally or maybe even another leg down in the secular bear. Either way, I think once the Dow:gold ratio breaks below the bottom of that range we will be heading into another major repricing of stocks compared to gold.

5 comments:

  1. Toby isn't it possible Gold retreats here instead? If you look at a weekly chart of Gold, it is at the top of its upward trading channel. It looks like to me it could fall to $1,000 an ounce first before continuing higher.

    In addition to price being at the top of the channel, we have a long-term divergence between price and the RSI and MACD. To me this would tend to suggest a possible pullback on the yellow metal once problems in Europe are deemed to have been pushed into the future.

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  2. Sure it could pull back. All bull markets do from time to time. Although I wouldn't waste your time with divergences. A great many rallies start with a divergence on MACD and RSI. I seriously doubt we will get anywhere close to $1000. The last intermediate cycle low tested the breakout above the `08 high at 1044. If gold enters an intermediate term correction I would look for a test of the 200 DMA.

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  3. I have been watching this ratio for many years now too. It is the basis for buy/hold gold plan, which I will keep until the ratio gets to 2 or 3. I do think we will be close to 1 as well.

    I would love to see gold pull back to $1000, that would be the opp to get fully invested in AU.

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  4. Jeff,

    Nice catch on the MACD divergence. I had not looked for that before you mentioned it. It has its similarities with early 2008, doesn't it?

    What you write makes complete sense to me - that a pull back to make a higher low on the weekly chart is 'in order'.

    The other possibility, of course, is that, ala late 2007, we are now departing a pennant consolidation and just half way up the tree.

    I would think we will know in just the next couple weeks. :)

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  5. I addressed this in last night's report. Gold is deep enough in the intermediate cycle that one definitely doesn't want to be leveraged but sentiment hasn't reached the kind of bullish levels that are ususally seen at intermediate tops.

    So if gold is nearing an intermediate top I would expect the correction to be much milder than what happend in Feb. and the move out of the intermediate low would then set gold up for a big move higher into the "bullish" fall season.

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