May 15, 2006

Hold Gold, Not the Dow

There has been a lot of bullish hype as the Dow Jones Industrials Average has approached the record high that marked the top of the stock market bubble in 2000. Be careful because much of this hype is seriously misguided.

On November 5th I advised that the stock market was over-priced and that investors would be better off by waiting in cash, but not ‘dollar-cash’. I said that investors need to be holding ‘gold-cash’. My recommendation was: “Ignore the bullish hype about the stock market, and stay in cash (i.e., gold) until the stock market returns to a better value (i.e., a much lower price in terms of goldgrams).”

From November 4th to May 12th, the Dow Jones Industrial Average has climbed from 10,530.76 to 11,380.99, an increase of 8.1%. At first blush that looks like an exceptionally good 6-month return. But we get a very different result if we measure the price of the DJIA in terms of gold. During this same period, when measured in terms of goldgrams, the DJIA fell from 717.82 to 498.36, an incredible decline of -30.6%.

Clearly, gold’s rate of exchange to the dollar (what we usually call the gold ‘price’) is rising more rapidly than the DJIA’s appreciation in dollar terms. Thus, despite what one might be hearing in all the misguided hype being bandied about as the DJIA approaches its all-time record high, you have been much better off since November owning gold instead of the DJIA. But this same strategy has made sense not only since then. It has also been the more prudent strategy for the past few years, as we can see from the following chart.

Even though the Dow Jones Industrials Average may be rising when we measure its price in terms of dollars, this venerable average is falling when we measure its price in terms of gold. In gold terms, stock prices have been falling since July 1999, six months before the DJIA peaked in dollar terms. The purchasing power of gold has climbed since then, with the result that stocks have become cheaper.

As we can see from the above chart, the downtrend in the gold price of the DJIA is well established within the declining parallel trend channel (red lines). I expect this downtrend in the gold price of the DJIA to continue in the months – and years – ahead. Therefore, continue to follow the safe and prudent strategy. Stay in gold (i.e., cash) while waiting for the price of the Dow Jones Industrials Average to drop to more reasonable, lower priced levels.

I’ll let you know when we get there, because I too plan to be spending my gold to buy the Dow. But be patient. We are a long way from a ‘reasonable’ price. To explain why, take another look at the above chart.

In January 1980 it took fifty goldgrams to buy the Dow. That’s the price I’m waiting for – when the Dow costs fifty goldgrams. That means the Dow still has to lose 90% of its value when measured in terms of gold. By this measure one could argue that the downtrend in the Dow (or more precisely, the uptrend in the purchasing power of gold) has hardly begun.

How long will it take for the Dow to fall to that fifty goldgram level? No one of course knows, but my guess is that it may take five more years, which explains why we need patience. It will take awhile for the Dow to fall to a reasonable price.

What will the dollar price of the Dow be when that happens? Again, no one knows, but we know exactly what the answer to this question depends upon.

It all depends on how badly the Federal Reserve inflates away the purchasing power of the US dollar over the next several years. My guess is that the Fed will do what it has always done – it has always done a good job at inflating away the dollar’s purchasing power, despite all the lip service it gives to the contrary by stating that its objective is to control inflation. So expect inflation to seriously erode the purchasing power of the dollar in the months and years ahead. After all, the Fed has a horrible track record, but here’s the important point.

As long as you own gold, the Federal Reserve cannot inflate away the purchasing power of your money. The Federal Reserve cannot inflate away the purchasing power of gold, and with that knowledge comes peace of mind, which is the most important objective of any investment strategy.

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James Turk is the Founder & Chairman of GoldMoney.com. He writes The Freemarket Gold & Money Report, and his latest book is The Coming Collapse of the Dollar.