Watching Dow/Gold Ratio to Signal Next Market Cycle
Aug 15, 2009 © Harry P. Schlanger
Technical analysis of the Dow/Gold chart reveals long-wave business cycles, allowing smart investors
to position themselves when to start buying either gold or equities.
There are two basic methods of
predicting prices in financial markets.
The first method is that prices ultimately reflect fundamental
values in the economy. Prices are determined by actual and expected developments concerning these
values; therefore, forecasting prices amount to forecasting fundamentals.
The second approach argues that most fundamental values are already discounted by the market and
forecasting prices becomes an issue of deciding what the market is “saying” about itself. It's
a matter of technically analyzing prices.
This article looks at a possible chart indicator to forecast crowd sentiment, find trends and
pinpoint reversals of the major business cycle. Historically, the ratio of the Dow Jones index and Gold
prices has been shown to be one such indicator.
Technical Analysis of Price
In technical analysis of a market, no account is taken of fundamental values because it is assumed
investors' expectations are already reflected in prices. The market is trying to anticipate the future,
with changes in prices preceding changes in fundamental conditions.
The rationale behind technical analysis is that people indulge in group behavior. Price movements and
indices of investor activity, such as the Dow, gold and crude oil, respond to information shocks and their
prices oscillate rhythmically in response to cyclic crowd sentiment. These
market rhythms
have been modeled as fixed, periodic cycles or as dynamic systems with aperiodic cycles.
Using the Dow/Gold Ratio
The Dow/Gold ratio has been found a useful measurement of price changes to reflect crowd activity in
the business cycle. It can be interpreted as the number of ounces of gold that buys one share of
the Dow.
Example:
- With the Dow at 10,000 and gold at 500, it requires 20 ounces of gold to buy one share of the Dow, so
the ratio is 20.
Why settle for the Dow/Gold ratio? The reason is that it shows the cyclical nature of the battle between
paper assets and hard assets. When the equity growth phase ends, and preservation of wealth becomes
paramount, gold tends to excel. A simple technical analysis of the chart data can reveal when
changes are likely to occur.
Dow/Gold Ratio Reveals the Business Cycle
The Dow/Gold ratio chart below shows a time period since the 1930s. It can be seen that there are
two main peaks and troughs varying from a ratio as low as 1 to as high as 42. When the ratio is on the
rise, it is time to buy equities but when the ratio peaks, one needs to switch to selling equities and
buying gold.
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