Ever since the March 2009 crash low, I've maintained my view that the Dow Industrials and broad U.S. equity markets were entering a new bull market — and that the Dow Industrials would eventually hit 31,000+.
One of the major tools I used to come to that conclusion back then was the ratio of the Dow Industrials to the price of gold.
I wrote extensively about it in my July 2008 issue of Real Wealth Report — even before the crash of 2009, which I also forecast — and several times since. Today I want to update that analysis for you.
First some background. At the peak of the ratio of the Dow Industrials to gold in the year 2000, the Dow Industrials would have purchased just over 51 ounces of gold.
During the financial crisis of 2007–09, as equities plunged and gold had rallied (since its bottom in 2000) the ratio collapsed all the way down to the 6 to 7 level.
In other words, in terms of gold — what I like to call "honest money" — the Dow Industrials had lost more than 87% of the entire equity bull market from 1980 to 1999.
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In my Real Wealth Report issue of July 2008, I called for the bottom in the ratio to come in around the 5 to 6 level.
It bottomed slightly above that level, then retested it with a slightly lower low in September 2011.
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Since then, stocks have vastly outperformed gold. Here's the chart I published back then, but with updated comments and analysis.
As a result, the ratio of the Dow Industrials to gold started widening back out, and also broke out of a resistance level, which you can also see on the chart.
Now trading at about the 14.5 to 1 level, the Dow/gold ratio is set to widen much further.
So what does this all mean? And what does it hold for the future for the Dow? For gold?
I'll answer those questions now. But I urge you to put your thinking cap on, because the analysis of the Dow/gold ratio is not easy to grasp, yet it's critically important to understanding the future.
FIRST, the collapse in the Dow-to-gold ratio during the financial crisis was not caused simply by a crash in equity prices. It was also due to a crash in the value of the dollar during that time period, as reflected in the soaring value of gold from the year 2000 on.
SECOND, the breakout in the ratio means that the Dow is now beginning to adjust its value to its ratio to "honest money" — as measured by its value versus gold.
This adjusting of equities is perfectly normal and one of the main reasons I am very bullish equities over the next several years (after a normal but sharp pullback occurs).
A simple exercise here will show you why. For the Dow/gold ratio to climb back to the 18 to 20 level resistance level you see on my chart, the Dow would have to explode higher to the 23,480 level, assuming gold's current price of roughly $1,174.
Naturally, the price of gold is not going to remain at $1,174. So let's run a simple matrix of the price of gold and assume the Dow eventually gets back to a ratio of 20 to 1.
Let's say, for instance, that gold eventually falls to $900. At 20 to 1, that would put the Dow around 18,000.
Or take a super-extreme, super bearish price for gold at say, $800. A 20:1 ratio puts the Dow at 16,000.
Clearly, there's not a lot of downside to the Dow even if gold were to plunge all the way back to $800 (which is highly unlikely).
Now, let's look at the flip side: What would happen to the Dow Industrials if gold were to move $1,500? Then to reach a 20 to 1 ratio, the Dow would have to explode to 30,000.
And at $2,000 gold, a 20:1 ratio would see the Dow eventually hit 40,000.
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Do this exercise for any price level of gold you wish, and you will see that the downside risk in the Dow is minimal and the longer-term upside potential is enormous. Ditto for gold.
That's not to say there won't be pullbacks in the Dow. There will be. We are in the beginning throes of one now. One which should be avoided, owning as few stocks as possible.
But given the breakout from the bottom of the Dow/gold ratio in September 2011 … and the normal tendency for all markets, no matter what they are, to retrace good portions of what they have lost ...
I believe it's a very safe assumption to make that the Dow/gold ratio will continue to climb. And that means — longer-term — much higher prices to come for the Dow, and U.S. equity markets in general.
As for gold and silver right now, the bounce you've seen is nothing more than a dead cat bounce. The precious metals, and commodities in general, have NOT bottomed.
But the bottoming process should soon begin.
As for the Dow Industrials right now, here too, the bounce you've seen is nothing more than a dead cat bounce. Stocks will head lower in the shorter-term — before blasting off again to the upside.
But once the equity markets and gold do indeed bottom — both will be off to the races on the upside, in rip-roaring new bull markets where both equities and gold will soar, together.
This analysis also shows you why it's so very important that you think out of the box. Most analysts will say I'm nuts to say gold and equities will eventually soar together.
But it's not nuts. And in fact, it has happened before, many times, the most important of which was between 1932 and 1937, when gold and the Dow both soared, together, in the middle of the Great Depression.
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The investment strategy and opinions expressed in this article are those of the author's and do not necessarily reflect those of any other editor at Weiss Research or the company as a whole.