In my efforts to quantify where gold would likely go in the next few years, I've become quite taken with the Dow:Au ratio. That ratio is the price of the Dow Jones Industrials Average in terms of ounces of gold. About five times in the 20th Century, that ratio reached or came very near to 1:1.
In every case where the Dow reached for new higher ground, as priced in gold, the ratio reached 1:1 first. Therefore, one clue to where gold is going to get when it reaches for its high in the current secular bull market for gold is to look at the Dow. (A much more detailed analysis of this matter is found here: http://www.gold-eagle.com/editorials_02/milhouse062002.html )
Several analysts have recently persuaded me that the next major drop in the Dow would take off about 40% of its current value. That could be forestalled if oil prices drop quickly in the next few months, or if the war with Iraq is very decisive and short-lived. However, there is going to come a recession, and when it comes, a drop by as much as 40% of the Dow's value is not unlikely. A similar drop in the S&P 500 would be likely.
Using today's value for the Dow as the value from which it would decline (which is not necessarily the case) we get a declined value of 4735. Yes, that is quite a drop from nearly 7900. Why would such a dramatic drop occur?
One analysis that is very common is price to earnings. It is such a common analysis that many listings of stock prices in, say, newspapers, indicate the P/E ratio for the stock. If you look at the P/E for major indices like the Dow or the S&P you find numbers around 22 right now, whereas through history the P/E has been closer to 15. Since earnings are not expected to grow dramatically any time soon, and a recession would be a strong argument against earnings growth, the logical expectation is for stock prices to decline. They may well decline to a point below a P/E of 15, in order to restore the overall trend.
Over what period would such a decline take place? It would start within a few weeks after a recession began, and continue for perhaps six months. I'm not forecasting it to start tomorrow. Indeed, there could be some rise in stock prices depending on how soon the war with Iraq starts and how well it goes.
Can the Dow:Au ratio drop below 1.0? Yes, I think it may. However, if it did, stocks would be widely perceived as tremendously undervalued.
Would a decline in the dollar or a widespread disillusionment in the dollar play any role? Yes, it would play a role in the dollar price of the top of the gold market, I think. It would not, however, affect the Dow:Au ratio since that is a valuation of the Dow priced in gold.
For the dollar price of gold to rise significantly above $4800 per ounce, I believe the US dollar would have to be experiencing hyperinflation or be widely abandoned by users, or both. By significantly above $4800, I would say 20% more. So, based on current conditions, I would estimate a top below $5760. When? In less than 3 years.
Regards,
Jim http://cambist.net/
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