Falling Dow-Gold ratio: Will history repeat itself?

March 07, 2009

Commodity Online
MUMBAI: There is a negative correlation between Dow Jones Index and gold prices in the long run. When the former falls, the latter goes up.

With the rise in Gold prices and falling stock markets, contrarian investors are ready with their guns to take on "opposite bets". Such investors go long on the so called cheaper stocks markets and short Gold. Will these investors be on the right side?

With out a crystal ball to peek into future, the only option is to look at historical movements of gold and Dow Jones Index, according to Quantum Gold Fund which has devised the Dow –Gold Ratio.

The ratio reflects how much investors are willing to pay for the Dow index in terms of gold. As we all know Dow is a measure of market values of listed companies and Gold is decade’s long measure of real asset value. A higher Dow reflects the overall well being of the US economy, earnings and vice versa. Whereas, a higher Gold price reflects the economic uncertainty and vice versa. Usually Dow and Gold are negatively correlated viz move in opposite direction over a longer time horizon, Quantum Gold Fund said in a report sent to its investors.

The Dow Gold ratio peaked at 42.36 in 1999 and has since been falling. It currently stands at 7.3. The Dow/gold ratio has fallen about 83% from its 1999 peak, which occurred when equities reached their highs at the top of the dot-com bubble and gold traded at 20-year lows.

Historically the Dow Gold ratio has peaked after intervals of nearly 35 years on an average. After each of the peaks, the ratio has fallen rapidly on a multi year downtrend to bottom out. below 2 (two). The fall in ratio was on account of stock markets collapsing accompanied by a rally in gold.

Currently, the ratio stands at 7.3. If history repeat’s itself like in previous two cycles and the Dow Gold ratio sinks below 2, where would be the Gold price?

Gold prices recently have not perched itself on the leading lady's head like the dove "Masakali", in the latest Hindi movie "Delhi 6". The gold prices are flying higher and higher. Gold revisited the $1,000/oz mark in February on increased demand from investors as a "store of value" and "a safe haven" in midst of the deteriorating global scenario.

Although profit booking and volatility has pulled it down in the short run to $915 levels, the long term uptrend remains intact. Gold in Indian Rupee remains the best performing asset class in 2009 (13.8%: upto 27th Feb 2009).

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