The Dow-to-Gold Ratio

The Dow-to-Gold ratio is an interesting statistic of some usefulness. It simply tells you how many ounces of gold it will take to buy one share of the Dow Jones Industrial Average. In layman's terms, it tells you whether gold is more expensive than stocks or visa versa.

The following excerpt from an article entitled "Why Gold is the New Currency."


"The median stock (as measured by the Dow Jones Industrial Average) to gold ratio over the last 106 years was 5.4. In other words, during the 20th century, on average 5.4 ounces of gold would buy one unit of the DJIA.

Today, it takes more than 12 ounces of gold to buy one unit of the DJIA. So in spite of gold’s mammoth rise from $250 to $860, the precious metal is still quite cheap relative to stocks.

So while the mainstream financial media and the Federal Reserve might be proclaiming an end to the commodity boom and the beginning of a new bull market in stocks, I don’t buy it. In real terms, stocks are anything but cheap. Gold on the other hand, is clearly undervalued."



Although I agree with a lot of the author's conclusions, I disagree with his conclusion that stocks are overvalued. Here's why.

First, the gold/stock ratio may not be a reliable indicator since they are always tinkering with the Dow components, which can make the true ratio an unknown. But I fully agree that gold is still undervalued LONG TERM.

Stocks however do not by default become overvalued simply because gold is undervalued. There is no rule of the universe that says two asset classes cannot be undervalued at the same time.

Short term I think you will see stocks rebound strongly for 2 reasons.

First, as boomers approach retirement realizing that they are needing to put away massive amounts of money over the next few years, this demand for stocks will push up their prices regardless of whether they are overpriced or not.

Second, as foreigners are dumping their dollars, they are buying US assets.....real estate and companies/stocks. The Arabs just traded some of their dollars for a stake in Citibank. They see value here, and they have shown themselves to be pretty astute investors.

It is the DOLLAR that gold is tremendously undervalued against. As the Fed continues to print more dollars out of thin air, by default, the existing amount of dollars become worth less and less. This increase in money supply is only going to continue to get worse, not better.

So, I can see gold going to $5000 against the dollar. And, if, for the sake of arguement, the historical 5/1 ratio holds true, then look for the Dow to hit 25,000.

Tangible assets...gold, stocks and real estate are the only safe harbors.