Dow/Gold Ratio Of 1:1 Or 2:1 In Coming Years?

Gold has given up some of last’s weeks very large gains and is down 0.6% after Asian and early European trading. With gold up some 13% so far in 2009, some correction and consolidation may be necessary prior to overcoming resistance at $1,000/oz.

The inverse correlation between stock markets and precious metals was seen again last week as gold and silver surged by over 6% while most major stock markets were down by some 6% (S&P 500 was down by 6.8%). This inverse correlation looks set to continue for the foreseeable future and as has happened in other stock bear markets gold bull markets, the Dow/gold ratio looks set to retest lows seen in 1933 and 1980.

As can be seen in the above chart featured in this week’s Economist, the Dow/gold ratio has been falling sharply since 2000 when the Dow Jones was over 13,000 and gold at some $260/oz. Since then gold has risen to nearly $1,000/oz and the Dow Jones has fallen to 7365. Thus the ratio is now just above 7:1. One ounce of gold can buy seven units of the DJIA.

Given that the financial and economic conditions today are far worse than in 1980 and arguably as bad as they were in the early 1930s (as warned of by Soros and Volcker over the weekend), it seems extremely likely that the Dow/gold ratio will again reach a low in this cycle around the 1:1 or 2:1 level.

This would mean that gold could reach its inflation adjusted high in 1980 of $2,400/oz and the Dow Jones fall to as low as 2,400 or 4,800.

Given the degree of money printing and credit creation we believe that soon deflation will abate and will be superceded by virulent inflationary pressures. This could lead to a Dow/gold ratio of 1:1 or 2:1 at higher levels ( the DJIA at 5000 and gold at $5000/oz or the DJIA at 6000 and gold at $3,000/oz) .

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