Talking relative value

Dow / Gold ratio with the Dow presented monthly, 1982 to 2012, with trendline

Dow / Gold ratio with the Dow presented monthly, 1982 to 2012, with trendline

We can learn lots about the markets in general and assets specifically by looking not a prices but at relative value. In other words, we don’t evaluate asset prices absolutely, rather we compare two assets and try identify which is cheap and which is dear.

The chart above shows what’s called the “Dow / Gold ratio”, in other words, the value of the Dow Jones 30 Industrials divided by the price of gold (grey shaded area). I’ve also included the Dow Jones 30 Industrials ($INDU, red line) for reference, and have fitted a trend line across the Dow / Gold ratio. Clearly this ratio is trading at near record lows, but how do we interpret this?

We haven’t seen the ratio this low since 1989 when it hit 6 as the US equity markets recovered from the Great Crash of Black Monday 1987. Some folks suggest this ratio has to fall to 1 before there can be a truly sustainable recovery.

I tend to agree that US equities are due for a fall, and gold is still looking pretty good. Some analysts believe this near term low is a signal that it’s time to buy gold. Time to buy and hold, as the markets are very, very unstable at the moment due to repeated government interventions.

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