Faith in the Gold-Dow Ratio

Wall Street did no damage yesterday. It left peoples’ money where it found it…as The Street took off for Labor Day. But the financial press didn’t stop…and neither did we at The Daily Reckoning.

The most amazing thing is that the people who are supposedly the most able thinkers seem unwilling to do any thinking. So many well-educated, smart economists spend their lives trying to understand what is going on. So few really seem to care.

So many economists…. If you could take all the world’s economists and lay them end to end, you should do it. The world would be a better place with out them.

And take Paul Krugman…please! He’s in The New York Times this morning with an analysis worthy of a Ph.D. economist/Nobel Prize winner…but unworthy of a first year philosophy student, cab driver or hairdresser. At least he is efficient. In the space of just a few well-chosen paragraphs he is able to misunderstand the entire economic world.

More on that too…but not today…

Today, we’re waiting… Wise investors spend 90% of their time waiting for something to happen. The other 10% of the time they are caught off guard when it finally does happen.

Here at The Daily Reckoning we are still waiting for the washout…the sell-off…the final leg down of the bear market that began in January 2000. The Dow should sink below 7,000. Most commodities should go down…along with art, collectibles, and labor costs. (Oil is down below $75 this morning.) US housing should lose another 10% to 30% of its value. Even gold should sell off…

…or maybe not.

How do we know this market downturn is coming, you ask?

We don’t. But it’s too likely to ignore.

“Stock market valuations actually hit their last low in the mid-’70s. They spent the next nearly 10 years shilly shallying around,” said an investment pro yesterday. Our friend in London has been operating an independent investment research company for nearly 30 years.

“It’s so complicated,” he went on. “And inflation distorts the picture. It’s probably best to think about it in terms of gold. Gold is the only real money. And bear markets are fundamentally an adjustment between money and stocks. Sometimes people are hopeful and want the upside of stocks. Sometimes they are fearful and want the protection of cash in hand. The adjustment can happen in either direction – either with an increase in the price of money or a decrease in the price of stocks.”

At the ratio’s peak in 1998, it took 43 ounces of gold to buy a single unit of the Dow – a single share in each of the companies that make up the average. Back in ’98, investors really took leave of their senses. They thought computers and modern communications were creating a brave new world where the old rules no longer applied. “This time it’s different,” they said, and paid good money for stocks in companies with no earnings, no history, and business plans that were little more than wishful thinking. Since then, investors’ optimism has been hammered out of them. By a bust in the NASDAQ, the 9/11 disaster, Bush II, Hurricane Katrina, Iraq, Afghanistan, the huge bubble of ’05-’07…subprime, another stock market bust, 10% unemployment, Lehman Bros., Obama, and other catastrophes. The ratio of gold to stocks has already come down to under 10. But there’s much further to go. At its low-point, gold and the Dow tend to trade at a ratio of 2 to 1…or even 1 to 1.

Where might we find the low point of this market?

“Well, maybe if gold were to rise to $3,000 and the Dow were to fall to 6,000, we might be at a bottom,” continued our London sage. “And we might be talking about another 5 to 10 years with no positive returns for the average stock market investor.”

We’re not wise enough to know what will happen. And we’re not fool enough to think we know. But there’s no need to take the analysis too far. A bull market takes prices up. A bear market brings them down. A bear market began in January 2000. The big risk is that the bear market hasn’t completed its work…that stocks, housing, commodities, etc, still haven’t reached their ultimate lows for this cycle. The danger of a new, major low is high. Investors should beware.

So we wait. And hold gold. Gold is not the only form of money. But it’s the best form. And money becomes more and more valuable as people seek protection from the bear market…and from other forms of “money.”

If we’re right, sometime in the future, investors’ fear will reach its climax. Money will be as valuable as it’s going to get. Assets such as stocks and houses will be as cheap as they are going to get. Then, it will be time to reverse the trade…

But hold on. You can get a good deal on great US companies now. The last time we looked, dividend yields over 5% were available now on some of the world’s best brand-name stocks – Altria, Eli Lily, Reynolds, Diamond Offshore Drilling…

Well, yes…there are some good deals available.

But if we’re right, even better deals are coming.

Bill Bonner
for The Daily Reckoning