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)

Reading Between Lines

These are taken from old interviews of Jim Rogers and Marc Faber. Its not editd very well. If read well it will enligten factors to consider when betting on the economy or narrowing down to stocks.

On the commodity bull run

If you go back in history, there you will see that the shortest bull market in commodities, that I found lasted 15 years, the longest bull market lasted 23 years. So, this bull market will last until sometime between 2014-2022. Thus commodities have got a long way to go, as far as I am concerned, because the supply and demand is seriously out of balance.

Opening up its commodity markets to foreigners would benefit the economy of a country like India because if you have a lot of commodities, which are unique to India, where people could make a lot of money and I am sure some people in India will make a fortune in the new commodities market, as they develop in India.

On crude price and where it's headed

There will be setbacks along the way, I mean, if Taiwan and China go to war, the prices of everything will drop for a while. If any major financial institution goes bankrupt, everything will go down. But nobody has found any oil for many years unless somebody finds a huge oilfield in Tokyo or in Mumbai or in Berlin, the price of oil is going to stay high and go much higher.

There has been no major oil discovery anywhere in the world for over 35 years. Oilfields are in decline and are depleting. There has been only one lead mine opened in the world, in over 25 years. The last lead smelter built in the US was in 1969, you weren’t even born then! So there has been no productive capacity added in most commodities for many years. So supply is going down, demand is growing. You know that's what’s happening in India, in China, all over Asia and all over the world.

The great oilfields of the world, Alaska for instance, is in decline. The Mexican oilfields are in decline. The UK, remember the North sea, it’s been a huge oil province, but the UK, which has been exporting oil for 25 years, would be importing oil within the decade. The platforms in the North Sea are closing down. Somebody has got to find a lot of oil very quickly or the prices are going to go a lot higher.

Marc Faber - "International liquidity has been tightening and global growth is slowing down. So maybe, we are not going to see prices of oil going up right away. I think the price of copper will rather come down than go up in the next six months or so. Having said that, I still maintain that in the long run, oil is a very desirable commodity to own because the demand in Asia is rising rapidly, at a time that the supplies can’t be increased meaningfully."

A premium can be built into the price of oil in the two scenarios (a) Say if the Chinese accumulate inventories or (b) If either the US or Israel will go and bomb Iran, then obviously oil would spark up and therefore I would be very reluctant to short oil.

On gold's glittering prospects

Marc Faber - We had that period of dollar strength and now in the last 2-3 days, the euro has strengthened again a little bit against the dollar. I suppose that if there is further dollar strengths, then gold prices could also ease somewhat. However, if I compare price of gold to say oil, then gold is very inexpensive. We can measure how many barrels it takes you to buy one ounce of gold - that ratio now is at a very low level. So in principle, I would almost be more tempted to buy gold than oil at the present time.

But price of gold would not rise in the following case, "Mr Greenspan has recently been tightening money supply growth in the US. He is increasing it at the slowest rate in 10 years. The international liquidity as expressed by foreign official dollar reserves, has been kind of, contracting. Therefore, this is not particularly good for gold right now. We have to ask yourself at what stage Mr Greenspan will ease again. He'll do it when he feels that the economy is weakening and since I believe that the economy is weakening, I see renewed easing sometime in the next couple of months and at that time, the dollar could tumble in my view, not so much against the euro as against gold and the other Asian currencies."

Roger's take on steel and iron ore

Steel is a manufacturing product. If it has excess manufacturing capacity, you can have a problem in the steel industry. The commodity is iron ore. I am more bullish on iron ore than I am on steel. Many steel mills have been put up in the last few years in China and in India, so I am not as optimistic about steel as I am about the underlying commodity, which is iron ore. Iron ore is in more of a short supply than steel.
There is over-capacity in the steel sector. The Chinese are still bringing in new steel mills onstream, and when you have new capacity continuing to come onstream, that is going to cause problems. Fortunately for the steel people, demand continues to grow, so the correction could go on for a while. I think I'm going to make more money in other investments than in steel.
On the global picture

Historically when commodities have been doing well, financial market have not, stock markets and bond markets have not doing well either. But if you own the oil, if you are in Canada or in Texas or in a place that owns the oil, you do extremely well. Other people may not do so well. In the 1970s, economies around the world were suffering. The price of oil went up ten times. It hurt some countries but still, we had a wonderful bull market in commodities and that’s what’s happening again. Thus commodities make new highs, the financial markets may not do the same.
On the whole, Rogers feels that stocks and commodities are both unlikely to see a buoyant market at the same time. He explained, "If you find the right stocks or the right companies, sure you make a fortune in the next 15 years but for the most part, that’s not going to happen. It’s happened many times, it happened in the 30s, it happened in the turn of the last century, it happened in the 70s, stocks just don’t do well when commodities do well.

Gold

Gold is Gold
Analysts believe that Gold should be a part of the portfolio. In 1849, gold was discovered in California. During financial crisis, countries have turned to gold for help. In 1937, when agricultural production slumped, India sold 1,400 tonnes of gold. In 1991, the Indian government shipped out 45 tonnes of gold to temporarily bail out the country of a severe money crunch. In 1979, at the height of oil crisis, the US dollar was devalued, buyers lost confidence in the currency and bought gold instead.

3 major areas of gold: Jewellery, Industry and Investing.
Jewellery accounts for 60% of the demand for gold. India is the largest consumer of gold and accounts for one-fifth of the global gold trade. 30% of the demand comes from investors who trade in gold exchange traded funds and from countries that hold gold as an alternative currency.

Reasons for the demand of gold
Investors are shifting from equities to gold. The US economy has been spinning into a recession because of a huge bumper consumer spending. The recent subprime crisis accelerated the shift.
With the dollar losing its grip, Asian countries have begun substituting dollars with gold in their investment portfolio.
China, which did not allow people to own gold, has deregulated. In 2002, Shanghai Gold Exchange was formed; opening up the demand floodgates so much that by 2007 China has overtook US to become the second largest consumer of gold.

Gold will be Gold

Of every 100 tonnes of gold, 70 tonnes comes from gold mines, of which 35 tonnes comes from 8 countries alone. Prodcutiong of gold is stagnating in few countries due to exhaustion of inexpensive mine-able gold resources and strict environmental laws.25% of gold comes from sale of gold reserves from the country. A treaty signed in 1999 for sale of 400 tonnes of gold annually by participating banks expires next year and don’t show any sign of renewal. Thus, going forward, gold prices are likely to stay firm.