Plenty of people pay close attention to the Dow/Gold Ratio. Eighty years after it sank to its Great Depression low, you might want to take a look this week, too.
This blunt measure of stocks versus the precious metal gets nearly 5 million results on Google, posting some 650 unique stories on the Dow/Gold Ratio. Search volumes for the term “Dow Gold” don’t quite match “Kim Kardashian” say, over the last 5 years (nor even “Reggie Bush”). But spiking in late 2008 and mid-2011, they very nearly matched search volumes for “Treasury bonds”—a market priced at twice the value of all the gold in the world. So why the interest?
The Dow/Gold Ratio maps, over time, how the Dow index of US stocks is performing in terms of gold, rather than just in nominal dollars. Dividing the number of points in the Dow Jones Industrial Average by the dollars in the gold price per ounce is simple enough. The aim is more complex, to show how investing in corporate America—the “world's most successful economy”, as Harvard professor Niall Ferguson reminds us—is doing versus a lump of non-yielding, relatively useless metal that does so little, it doesn’t even rust.
Investment in corporate America was doing very badly 80 years ago yesterday, for instance. As the Great Depression really got motoring, the Dow/Gold Ratio marked Independence Day by dipping to its lowest reading since 1900, just after the Dow Jones Industrial Average was first born.
That Friday, July 8, 1932, the Dow closed at just 41 points, while the gold price held firm at $20.67 per ounce, then its official price as mandated by the United States’ Gold Standard Dollar. Priced in gold (which was still money back then), the US stock market dipped below 2.0—and showed a drop of over 90 percent from its peak of only three-and-a-half years before, hitting what then proved its lowest level of the 20th century.
Yet US Inc came to do worse still compared to the gold price in January 1980, however, when the Dow/Gold Ratio fell to just 1.0—down more than 96 percent from its new record high of New Year 1966. So today’s equity investors might take heart from the last 10 months’ turnaround. Because sliding from the tech stock bubble’s new all-time peak above 40, the Dow/Gold Ratio has risen after hitting a two-decade low beneath 6.5 in September 2011.
Indeed, the Dow Jones index has outpaced the gold price by 25 percent since last summer. Just think what the outperformance would have been if, say, Apple had been added to the index instead of, say, Cisco when the Dow was last updated in 2009.
But that’s the problem with taking the Dow as a serious guide to anything much. Or so say its detractors, and they have a point. Or five.
While it’s not immutable—as gold is—the Dow Jones index still changes little, despite the changing fortunes of America’s biggest stocks. The Dow also includes only 30 out of the thousands of listed stocks traded on US exchanges, and 30 hand-picked stocks at that, chosen by a committee with few hard rules. Nor does the index weight those 30 stocks by their size in the market. Instead, it adds up their share prices, and then divides by a “Dow divisor”, an arbitrary number (currently 0.132129493 according to the Wall Street Journal) which itself has to be changed any time there’s a stock split or switch in the membership. That means that highly-priced stocks have more impact than lower-priced stock in much bigger companies.