An important ratio appears to have signaled a new bull market for gold
Gold topped a six-year high Tuesday morning, with its spot price briefly topping $1,534, its highest level since April 2013.
It pulled back in Tuesday’s afternoon trading, but then it climbed 1% yesterday, and is holding well above the $1,500 mark at $1,520 as I write Thursday morning.
Whether you attribute these most recent gains to Hong Kong unrest, the debacle in Argentina, or yesterday’s inverted yield curve is irrelevant. The bottom-line takeaway is simple — gold is moving.
So, where’s it going next and should investors get in?
Gold can be challenging to value, which can make its future direction harder to predict. You see, gold isn’t a productive asset. It’s not tied to a business that generates profits which we can discount to arrive at an appropriate valuation … nor does it pay a dividend that we can use to back into a suitable market price.
You could argue that gold’s value is entirely derivative — whether it climbs or falls has less to do with any specific qualities that are intrinsic to the asset itself, and more to do with a series of external influences … among them, the strength of the U.S. dollar, the health of stocks, the level of interest rates, and, of course, investor sentiment.
Now, in today’s Digest, we’re not going to dive into all of these influences. Instead, I want to point you toward one specific ratio. It’s a long-term, macro indicator for gold. You could make a strong case that it has recently signaled a new, long-term bull market in gold — regardless of whether that’s due to the dollar, interest rates, or whatever. But if this indicator truly has flipped, then history suggests you want some of your wealth in gold as soon as possible.
So, today, let’s dig into the details as we answer the question, “where’s gold going next?”
***Part of the challenge when answering “where is gold going?” is “well, what’s your time frame?”
I won’t try to tell you where gold’s price will be tomorrow, next week, or even next month. These short-term fluctuations are based on myriad factors that are entirely unpredictable. But over a much longer period — usually years — these factors tend to net out, and gold’s price movements have clearer patterns.
For example, below is a chart of the indicator we’ll discuss today, which I’ll reveal in a moment. It covers the period from roughly October 1981, through September 1982.
Looks pretty erratic right?
Over the course of almost a year, the market performance of this indicator is uneven at best.
So, within the parameters of this time-frame, is this mystery indicator “up” or “down”?
Well, it’s clearly up, but in an obvious downtrend. Seems a bit hard to find its sustained direction, right?
Let’s pull back now and examine this same period of market performance within a broader context.
Below, we see the same “October 1981 through September 1982” range, yet also the surrounding years from the late 1970s through 2000. I’ve circled in black the time-period we just highlighted.
(By the way, the charts below feature what’s called a “logarithmic” scale on the Y-axis. It’s used when the values cover a wide range. It helps make the data easier to see without the chart having to be huge.)
On this scale, is the indicator moving “up” or “down”? Well, it’s obviously much higher in 2000 than it was in 1980. The pattern is clearly “lower left to upper right.”
So, “up/down” or “gains/losses” is a function of your preferred time-frame.
***When it comes to gold and today’s investment markets, we need a longer time-frame to help contextualize what might be happening right now
With that in mind, I’m going to suggest you ignore chatter about gold’s short-term price movements. It can distract you from long-term trends. And there will be lots of chatter from the talking heads in coming weeks.
You see, there’s a case to be made that gold’s price needs to take a breather given its rocket-like ascent over recent months. But I believe any short-term weakness could be masking deep, powerful, long-term strength.
So, if we remain focused on a longer-term investment horizon that’s rooted in historical trends, gold appears poised for a move … potentially, a very big move.
On that note of “trends,” let’s now reveal which chart we’ve been looking at, since it’s instructive to our primary question of “what’s gold going to do?”
***Meet the Dow/Gold Ratio … and why gold is in for huge gains if it has truly flipped
The charts from above feature the Dow/Gold Ratio.
It’s exactly what it sounds like. It’s a chart that shows the relationship between the price of the Dow Jones index, relative to the price of gold.
Here it is from about 1950 through today (the shaded areas are recessions).
So, how do you read this?
Well, if the value is getting higher, it means the price of the Dow is climbing relative to that of gold (simplistically, stocks are outperforming). If the value is getting lower, it means gold’s price is rising relative to that of the Dow (simplistically, gold is outperforming).
For example, from about 1980 through 2000, the ratio is climbing. That reflects the epic bull market in stocks that took place in the 80s/90s, leading up to the Dot.com Bubble/bear market.
Of course, then this ratio reversed. Beginning in the early 2000s, gold’s price began soaring relative to that of the stocks. For example, on December 31, 2001, gold was trading at about $280. But then, while stocks went sideways for a decade, gold made its move … fast-forward about 10 years, and it peaked at roughly $1,890 in 2011.
This is represented in our chart above by the ratio-line falling steeply from 2000 through 2010ish.
But then what happened?
Well, you can see that the Dow/Gold Ratio flipped again, and the Dow began outperforming relative to gold. This mirrors the epic, historic bull market we’ve been enjoying since the Global Financial Crisis.
But now, let’s zero in on what’s been happening with this ratio recently …
***Have we just passed an inflection point in the Dow/Gold Ratio?
Below we look at the chart since the early 2000s, adding in simple trend lines.
Notice the right side of the chart, where I’ve circled the point at which the ratio has now broken beneath its long-term “Dow outperforming” trend.
Now, does this mean that the ratio has officially flipped, and we’ve just entered a new multi-year upswing for gold?
Given our long-term timeline, we should be cautious in jumping to that conclusion. But from a straight technical perspective, the chart above presents a strong case.
But here’s the thing — we don’t need to know definitively whether the ratio has flipped or not to respond in a wise manner. And in this case, wisdom means adding at least some gold to your portfolio.
It doesn’t have to be drastic — I’m certainly not suggesting you liquidate your stocks and rotate completely into gold. But look again at the Dow/Gold Ratio chart on a long-term basis …
If the ratio has truly flipped now, and we’re about to experience a multi-year period of gold outperformance, don’t you want some money exposed to it?
Remember, gold rose roughly 600% in the 2000s, while stocks went sideways. If we’re standing on the cusp of a similar sideways market for stocks (following the end of this historic decade-long bull market), then don’t you want some of your wealth benefiting from a bull market in some other asset? In this case, gold?
***The tailwinds pushing gold higher
As I wrote earlier, it’s not the goal of today’s Digest to dive into the details of all the factors pushing gold higher, but we’d be remiss not to draw your attention to a handful of them.
For example …
Central banks around the world are rotating into gold. In Q1, the world’s central banks bought more gold than any first quarter for six years.
This was followed in Q2 by an 8% increase over the same period last year.
Then we have central banks around the world looking to devalue their respective currencies, most notably China. If governments are intentionally trying to make their currencies worth less, don’t you want some of your wealth in an asset that will hold its value better?
Then we have interest rates around the world going toward zero (or below). This virtually eradicates the opportunity cost of being in gold since you’re not being rewarded to hold interest-paying assets.
Then, just yesterday, the granddaddy “yield curve inversion” of them all officially triggered, when the yield on the benchmark 10-year Treasury note broke below that of the 2-year U.S. note. Historically, this inversion has been heralded by many as a recession indicator.
If we are on a collision course with a recession some quarters down the road, then historically, gold is a good safeguard for your wealth.
***Last, don’t take my word for it. Instead, follow the advice of two of the most successful money managers in the world
For instance, in a Digest last week, we noted how billionaire hedge fund manager Ray Dalio is suggesting investors put money into gold.
There’s also billionaire Paul Tudor Jones — one of the best traders of all time.
Recently, he was quoted as saying:
If I had to pick my favourite trade for the next 12 or 24 months, it’d probably be gold. I think if it goes through $1,400 an ounce, it goes to $1,700 … quickly. It has everything going for it in a world where rates in the US are conceivably going to zero.
Gold has obviously blown through $1,400 and is moving fast toward $1,700.
But remember, even that move would potentially be “short term.” The name of the game I want to play is “long-term” and that’s where the Dow/Gold Ratio comes in. If it really did just flip, then $1,700 will likely be a distant memory in our rearview mirror when gold’s price hits its peak some years down the road.
***If you want more on the tailwinds behind gold, look to Eric Fry
Eric is a brilliant, macro investor with a multi-decade-long career highlighted by more 1,000%+ returning picks than anyone we know of in the financial newsletter industry. Today, he writes two investment letters — Fry’s Investment Report and The Speculator.
While there are various sectors of the market he’s highly bullish on today (like solar), Eric is also aware of the potential for a broad bear market. That’s why he wrote Bear Market 2020: The Survival Blueprint.
One particular bear market strategy Eric likes involves gold.
Now, it’s one thing to talk about bear market strategies — it’s an entirely different thing to see what they actually do in real time.
On that note, yesterday, the Dow Jones fell 800 points — down 3.1% on the day.
So how did Eric’s Speculator portfolio perform? Perhaps down only 2%, maybe down only 1%?
It actually pulled out a small gain of 0.2% yesterday.
Thanks to his gold positions and his six short positions (which rallied an average of 13.4% on the day), Eric’s defensive strategies enabled his portfolio to make money on a day that saw the Dow plunge 800 points.
That’s the power of planning ahead. That’s the power of a defensive mindset.
To learn more about Eric’s picks in his Speculator portfolio, click here.
Now, it also turns out that the monthly issue of Fry’s Investment Report comes out today. In it, Eric delves into far more details behind gold’s ascendancy — it’s a special “All Gold” issue. I’ve gotten a sneak peek at it, and it’s impressive. If you’re looking for a deeper dive into the case for gold’s tailwinds and why it deserves a place in your portfolio, I encourage you to click here to sign up for Fry’s Investment Report to get the specifics.
As we wrap up, I can’t tell you where gold will be a month from now. Frankly, it could very easily be lower. But if the broken trend line of the Dow/Gold Ratio chart does, in fact, signify an inflection point, then gold has likely just begun a long-term climb. And that would mean much higher prices over the coming years.
We’ll continue to keep you up to speed.
Have a good evening,