GOLD AND EQUITIES: HARD VERSUS MONETARY ASSETS AND EQUITY-TO-GOLD RATIOS

GOLD AND EQUITIES: HARD VERSUS MONETARY ASSETS

Earlier in this chapter, several currencies were measured in terms of gold in order to gauge their true strength, rather than simply measuring them against the U.S. dollar or other currencies. Similarly, gold can fulfill the same purpose for major stock indexes. Instead of measuring the value of the S&P 500 or Dow Jones Industrial Average index against the U.S. dollar as is customarily done, we can price it in gold terms. As in the previous

FIGURE 1.11 Falling gold production results from South Africa’s supply prob-lems, but China’s recent number one position in world production fills the gap. Source: U.S. Geological Survey (http://www.goldsheetlinks.com/production.htm).

exercise with currencies, pricing the major stock averages in terms of gold enables a truer perspective for equities because they are compared against the currency of gold, whose value is solely influenced by natural forces of supply and demand and cannot be manipulated by any issuing authority as is done to national currencies by their central banks. And since gold cannot be easily produced as the way money is printed, its secular nature presents a fair benchmark for valuing other assets. By comparing gold with equities, we assess the two most popular measures of corporate market value seen in the major equity indexes (stock indexes) to a classic measure of real asset value (gold).

Before we look at the equity/gold ratios, let’s examine the growth in gold prices versus that of major equity indexes. Figure 1.12 shows this growth comparison between January 2002 and May 2008. The beginning of the period occurred near the start of the bull market in gold while coin-ciding with the intensification of the bear market in equities. As of May 30, 2008, gold was 221 percent greater than where it was at the start of 2002, while the S&P 500 and the Dow Jones Industrial Average were 21 percent and 25 percent higher. But note that since their peak in October 2007, both the S&P 500 and the Dow have dropped nearly 20 percent, while gold rose by 50 percent over the same seven-month period.

For a longer-term perspective on equities and gold, Figure 1.13 com-pares their performances between January 1997 and May 2008. Note how gold carved out a bottom in early 2000, about the same time that eq-uities topped out. What followed was a four-year inverse relationship

FIGURE 1.12 Gold rose 10 times faster than the S&P 500 and Dow Jones Indus-trial Average between January 2002 and May 2008.

FIGURE 1.13 Although equities recovered from the 2000–2002 bear market, their gains paled compared to gold’s recovery.

between equities and gold, with the latter prolonging its bull run and the former shedding losses during the post dot-com bust. When the U.S. and global economies recovered by the end of 2003, both equities and gold advanced higher, with the metal rising at a growth rate 10 times faster than equities.

EQUITY-TO-GOLD RATIOS

The rapid rise of gold relative to equities since the start of the decade may elicit some skepticism about the durability of the rally and whether the metal is in the midst of an expanding bubble. Having compared the growth of gold relative to equities, we now look at the two in relative terms by ex-amining the equity/gold ratio. The ratio compares a commonly used mea-sure of market value versus a decades-long measure of real asset value. Gold is known to measure real asset value because of its ability to pre-serve value during inflationary times. Since prior charts (Figures 1.12 and 1.13) have demonstrated a significantly faster growth rate in gold than in equities, it logically follows that the equity/gold ratio has fallen off its 1999 peak. Figure 1.14 charts the Dow/gold ratio and S&P 500/gold ratio since 1920. Both ratios have fallen more than 200 percent off their 1999 peak, which occurred when gold hit its 20-year lows and equities reached their highs at the top of the dot-com bubble.

Notably, since the 1920s, the equity/gold ratio has peaked approxi-mately every 35 to 40 years: first in the late 1920s, then again in the mid-1960s, and once more in the late 1990s. Following each of these three peaks, stocks fell in a multiyear sell-off, accompanied by a rally in gold.

FIGURE 1.14 The plunge in the equity/gold ratio reflects the overall recovery in tangible versus monetary assets.

Once having peaked in 2000, stocks headed into a three-year bear mar-ket before recovering in 2003 and hitting new highs in late 2007. But as we saw earlier, stocks’ 2003–2007 recovery did not prevent the equity/gold rally from extending its decline due to the accelerating advances in gold. (See Figure 1.15.)

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The principal conclusion to be drawn from the near 90 years of equity/gold analysis is that each peak was followed by a full retracement to the lows preceding each advance. If this pattern holds into the future, then the equity/gold ratio has further declines ahead of it until recapturing the lows of the early 1980s. Whether this occurs via a faster decline in equities or persistent acceleration in gold’s advances remains to be seen. Chapter 8 makes the case for a prolonged increase in the current commodities boom, in which gold will likely play a considerable role. The confluence of sup-ply and demand factors boosting the broad commodity story suggests the bullish trend is unlikely to be reversed soon. Accordingly, prolonged de-clines in the equity/gold ratio will also imply that the real-asset values of tangibles such as metals, energy, and agriculture/food products will main-tain their upward trajectory. A return in the equity/gold ratio to its low levels of the late 1970s through early 1980s is more than plausible.

FIGURE 1.15 The equity/gold ratio recovered from its lows of March 2008, but the fundamentals underpinning commodities relative to equities suggest a limited rebound.

And while we are on the subject of the interaction between gold and monetary assets, it is worth weighing in on the current gold rally by com-paring the amount of gold available versus the creation of monetary as-sets. Just as we have seen the ratio of major equity indexes to the price of gold falling to 13-year lows in late 2007, the ratio of total financial assets to physical gold is near the low end of its historical range. As a share of the valuation of all global stock markets and global bond markets, the world’s available gold stands at a mere 3 to 4 percent, which is about four times lower than the ratio of the 1980s. Note how this difference in magnitude is similar to the aforementioned difference between the gold/equity ratio as of May 2008 and that of 1980, which was also four to five times greater.

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