Monday, April 5, 2010

Stock Market Value: The Dow-Gold Ratio

In light of the Dow’s extraordinary resurgence over the last 12+ months, where it has risen from about 6,600 to nearly 11,000, it is worth (pun intended) putting that figure into perspective. With that in mind, I present you today’s chart courtesy of (for a better graphic of the chart click on the link).

Pay attention to the “fiat capital era,” which is the one marked by the creation of the Federal Reserve Board—the U.S. Central Bank. Fiat literally means by decree; in other words, value is not set by the economic law of scarcity but rather by political legislation. A Dow measure of, say 11,000 is insignificant unless it is compared against a standard of value. Gold has historically been such standard.

As you can see from the graph, true stock market bottoms are set when the Dow-Gold ratio is between 1.5 and 3.0. Presently the ratio stands at 9.74, which about 33 points below of the all-time high set in 1999. Two things have caused this shrinkage: the Dow has declined and gold has risen. Based on this measure of value, the stock market is significantly overvalued on a long-term basis. This will be corrected in our generation. What is impossible to predict is exactly when it will occur.

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