The Golden Ratio

The three great bull markets of the Twentieth Century are dramatically reflected in a chart of the Dow/Gold ratio, which is simply the quotient of the Dow Jones Industrial Average divided by the gold price in US Dollars. It is basically the price of the leading index of paper claims on productive assets, divided by the dollar price of an ounce of gold.

When the ratio is high, as it is in a boom, equities are expensive and gold is cheap.
When the ratio is low, as it is in a bust, equities are cheap and gold is dear.

Today, the Dow/Gold ratio is at its highest level ever. We believe this signifies the financial world is on the cusp of a huge inflection point, similar to that of the two prior peaks.

Just as at those prior peaks, financial assets are grossly overvalued, and gold is grossly undervalued.

Just as those prior valuation extremes resolved themselves through dramatic reversals in both the numerator and the denominator of the Dow/Gold ratio, so will today’s, and soon.

The key to understanding the Dow/Gold ratio and what it portends lies in isolating the principal factors that affect the numerator (equity prices) and the denominator (the price of gold).

At every peak, we find the same phenomena:

- Overvaluation of equities
- Over-ownership of equities
- Excessive liquidity
- Excessive credit

At every trough, we find their opposites.

And at each extreme, we find a background of breakdown in the global monetary system:

- Collapse of gold exchange standard (1929 -1934)
- Collapse of Bretton Woods standard (1961 -1971)
- Collapse of floating rate standard (pending)