What Bull Market in Stocks?

“An investment in knowledge pays the best interest.”
—Benjamin Franklin

Before We Get Started…

Investors often believe when markets go up they’re getting richer – but they may not be. The value of their portfolio or home may be higher, but the value of the dollars they own may have been diluted/devalued/printed away by the government. And this is often brought to light by the price of gold vs. dollars or things denominated in dollars – like stocks. We believe the relationship between the number of ounces of gold it takes (in dollars) to buy one unit of the Dow (in points) is an important one.

Bear Market in Stocks?

Yes, a bear market in stocks. Despite rallying substantially since its 2008 lows, today the Dow stands at 11,205.[1] At the beginning of 2000 the index was 11,501 points.[2] In other words, since the start of 2000 the index has lost -2.6%. One could call it a lost decade for many stock investors.

Or worse. The more substantial ongoing bear market is the one in the Dow vs. gold (which has been considered real money for thousands of years). The index has been getting walloped vs. the precious metal for more than a decade. Let’s look at the chart below – which tracks the Dow/gold ratio (i.e. how many ounces of gold it takes in dollars to buy one unit of the Dow in points) back to 1901. We see in 2000, it took around 40 ounces of gold (in dollars) to buy one unit of the Dow (in points). In other words:

Dow 11,501[3] ÷ $282[4] per ounce gold = 40.8.

Today 9.7 ounces of gold (at $1,153[5] an ounce) buys one unit of the Dow (at 11,205[6] points). To sum it up – in a little over 10 years the Dow has lost 75% of its value vs. gold.

After a 75% drop – it would be tempting to say the bear market in stocks vs. gold has nearly run its course. However, it may be nowhere near over.

Source: ShareLynx.com

By further examining the chart all the way back to 1901 – it gets more interesting. Let’s remember the Federal Reserve Bank – which can create money out of thin air – came into existence in 1913.[7] We can see the swings in the Dow/gold ratio were relatively mild between 1901 and the early 1920′s. Beginning with the monetary expansion of the 1920′s[8] the swings in the ratio have grown wider. The chart shows the Dow peaking vs. gold at ever-increasing ratios of 18, 27, and 43 ounces of gold (in dollars) to buy one unit of the Dow (in points). The chart also illustrates the Dow bottoming vs. gold at decreasing ratios of 2 and 1 ounces of gold (in dollars) to buy one unit of the Dow (in points).

With the Dow currently at 9.7 ounces of gold – history indicates the ratio may have to drop much further for the Dow to bottom vs. the precious metal. If that bottom were in fact at 1-2 ounces of gold – what would that mean? With gold currently trading at $1,153 an ounce – would the Dow have to drop to 1,153-2,306 points (1-2 times the price of gold)? Or at today’s Dow at 11,205 – would gold have to go to $5,602-$11,205 an ounce? Or with continued government money printing (inflation) in an attempt to stimulate the economy and pay the massive national debt – would this mean higher Dow and even correspondingly higher gold?

We’ve long believed in the inflationary scenario. Actually our main concern is hyper-inflation (high levels of money printing) as the government continues to increase spending and the debt at unsustainable levels. Others seem to agree with us. We notice central bankers who not long ago sold gold en masse in the $300 range – today buying gold en masse at over $1,100 an ounce.[9] What does this say about current inflation expectations among central bankers?

And those who’ve put their trust in the government – the most conservative investors – may be most at risk in a hyper-inflationary scenario.

As always, we believe multiple opportunities exist. In this instance, it’s our opinion they include owning the right well-run companies.

While there is a lot of tough reality going on out there – we maintain our positive outlook. That outlook is based on our belief that a bear market in one thing is often a bull market in another.

As we enter this critical time – now, more than ever – we believe investors need to focus on their investment strategies. Those readers who are clients are fully aware of the strategies we’re implementing in light of unfolding economic circumstances. Others may feel free to contact us to learn more.

Sincerely,

Stephan R. Ernharth, JD
Vice President
Ernharth Group
www.ernharth.com

Go to www.ernharth.com/economic-commentaries to read past articles from our Economic Commentary series.

1.Yahoo! Finance; “Historical Prices for Dow Jones Industrial Average”
2.Ibid.
3.Ibid.
Kitco Metals
4.Ibid.
5.Yahoo! Finance; “Historical Prices for Dow Jones Industrial Average”
6.Wikipedia; “Federal Reserve System”
7.Ludwig von Mises Institute; “Money and Freedom”; February 2, 2000
8.Bloomberg; “Central Bank Gold Holdings Expand at Fastest Pace Since 1964″; March 18, 2010