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Using History To Determine The Market Bottom

20 February 2009 3 Comments

It is generally well accepted that the last two major economic downturns in America were the Great Depression of 1929/1930 and the recession in the 1970’s.  What does the market bottom of those two economic collapses show us about where the market should bottom today?

As I discussed in the last post entitled, “What Is Value?”, it is hard to determine the bottom of the market today in dollar terms because simply there are way more dollars in circulation today compared to the 70’s and especially the 20’s.

If you compare the market with the price of gold, arguably a better judge of value over a fiat currency, we get the following: in 1930, the Dow was 37 and the price of gold was 35; in 1980, the Dow was 800 and the price of gold was 800.  Both bottoms, we hit a Dow / Gold ratio of 1 to 1.  That should be pretty frightening for anyone holding US stocks right now.

I can say we can probably bet that we have lower to go since right now we are at about a Dow / Gold ratio of 7.5 (Approx. Dow: 7500, Gold $1000).  Will we get to a 1 to 1 ratio?  Maybe, maybe not, but I imagine we’ll get below 5 to 1.

I guess the question would be what would prevent us from getting to a 1 to 1 ratio?  It seems like there is more support to get to that ratio than support for a higher ratio.  For one, we are in the biggest deleveraging process the world has ever seen.   Just about every entity is over-leveraged, from the individual to the government to the corporations.

Why The Government Can’t Stop The Move Towards A 1:1 Dow / Gold Ratio

The government is powerless to stop this ratio.  Only a stronger economy can stop the ratio.  Massive government spending can maybe create some economic activity and cause the stock market to rise, but they are likely to push the price of gold much higher due to inflationary / monetary problems.

Use your head and think about the situation.  There is widespread, serious economic issues going on right now.  Unemployment should continue to rise which will continue to annihilate the consumer which will continue to kill earnings for companies which will bring the stock market down more.

Perhaps, the Dow will hit 5,000 and gold will hit $2,500.  This would be a 2 to 1 ratio.  Only time will tell.

Conclusion

Do you want to fight against this trend?  I don’t think you should.  If you want to own US equities, you better have some money in gold to hedge against this.  Gold at $1,000 might seem high right now and you might think you missed the boat.  I don’t think so.  Sure, it will have short term, volatile movements but I think over the next year or two, it will be much higher.

I own gold stocks such as AUY, GDX (ETF), and a couple junior mining companies.  I also own a little GLD and SLV.  Lastly, the only major position I have in stocks is Philip Morris Int’l which is a stable company that should benefit from a weaker dollar.

I’m also thinking about putting a chunk of money in actual gold through something like Goldmoney.com or the Perth Mint.  Something located outside US is preferred.

As the Dow / Gold ratio continues to go lower, there should be some nice opportunities to cash in gold and gold stocks in exchange for other assets.  I’m not going to think about doing this until the ratio is under 5 and even then I will probably continue to hold.

Look, we are in a major crisis; I’m not going to sugar coat it.  There is simply too much macro economic headwinds for even the fundamentally sound companies such as Apple to warrant any major exposure to US stocks.  If you’re holding a stock, make sure you’re at least getting a nice dividend.

If you decide to listen to somebody who says we’ve hit a bottom, they better be able to offer a compelling reason why.  People call a bottom on TV and on the internet every week; and every week they’ve been wrong.  I prefer the historical Dow / Gold ratio during major economic recessions / depressions.

Whatever you choose to do, good luck!  Many of us will need it!

3 Comments »

  • Joel said:

    Kevin ,

    I totally agree with you about the Dow/Gold Ratio. It not a even a debate whether it will reach 1:1; its a matter of when it will happen. Kevin I suggest you read Harry Browne’s FailSafe Investing. The best book I’ve ever read in my life. The book was initially released in 2003 but updated in 2005 via ebook. You can purchase the ebook for $10 online here:
    http://trendsaction.com/books/HarryBrowne/FailSafeInvesting/index.php?ulaCartSID=sqsAQuYXMtJMipQgsZrBzRryh1224637535

    His portfolio allocation is simple: 25% for each asset class……SP 500 Index, Gold, Treasury Money Market Fund, & Treasury Long Term Bonds. Each asset class responds differently to economic conditions. For instance, Gold for inflation, LT bonds for deflation, Cash for recession, and Stocks for prosperity. His portfolio is truly diversified in that it protects you in all economic climates. If you used his portfolio last year, you would have gain 1% on your investment!!!

    Dating back to 1972 (gold standard removed), his portfolio only had 4 losing years…1981 = -5% and the other three years were barely a 1% loss. Cumulative Annual Growth Rate for this portfolio is 8.70% with a standard deviation of 8.30% since 1972 while the SP500 is 8.55% and a deviation of 18.30%!!

    If you want more information about this portfolio purchase the ebook or visiting crawlingroad.com which is a site created by a blogger devoted to Harry Browne’s portfolio.

    Also, I see that your considering physical gold; I’m using GoldMoney.com and its pretty good so far. I wish they would allow ACH transfers but instead I have to wire funds to them which my bank charges for. But besides that I think they’re a great company. Nice blog by the way.

    Joel

  • Gennaro said:

    Agree that gold will continue to do well as the market struggles. If we only knew where the market bottom will be…perfect time to invest.

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