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Either-Or . . . or, Neither ?

11/21/2012

Not all relationships have meaning.  For example, take a look at this chart:

Chart of the Day
It shows the Dow divided by the price of gold and suggests two possibilities:  Either the stock market is too low or the price of gold is too high.  Which is it?
At first blush, you might say the great uncertainty we’re experiencing is scaring investors out of the stock market and into the “security” of gold.  But, notice the chart begins in 1978, covering the last 34 years.  The downward trend begins about year 2000.
Since that time, our national budget surplus has turned into an annual deficit — following two unfunded tax cuts, two unfunded wars, and a huge unfunded drug program for seniors.  (Unfunded means tax cuts were not matched with spending cuts or that spending increases were not matched with tax increases.  This is similar to Congress thinking they can suspend the laws of gravity.)  This long period of increasing deficit spending suggests gold is over-priced — compared to stocks.
Also suggesting the price of gold has risen too much, the demand for gold as jewelry increased significantly in Asia in general and India in particular during their explosive growth over the last twelve years.  
Traditionally, gold acted as a “store of value,” meaning people would buy some gold coins and hide them in their safe deposit boxes.  Increasingly, gold has become an alternative to currency investing.  Investors can speculate or bet on the Euro falling by buying gold on the stock market (see GLD), which is not included in the Dow or the S&P 500.  This increased demand for gold drove up the price of gold without simultaneously driving up the Dow or S&P 500.
This chart suggests a simple binary relationship that is more coincidental than meaningful.  I believe that both soon will soon turn bullish — regardless of what this chart suggests.

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