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Identifying trend changes of the Dow-to-Gold Ratio using the MACD Indicator
About Dow-to-Gold Ratio
The “Dow to Gold Ratio” (DTG) is a number that tells us how many ounces of gold would be necessary to buy the Dow Jones Industrial Average index (DJIA) at any given time. The calculation is made by dividing the value of the DJIA to the ‘spot price’ for gold.
The image below illustrate calculation of the “Dow-to-Gold Ratio”. In the first image, DJIA is at 19,500 and the gold spot price is at $1,300, making the DTG ratio equal to 15 (19,500 divided by 1,300 = 15). In the second image, the DJI increases to 20,800 and gold spot price is still $1,300. In this case, the DTG is 16 (20,800 divided by 1,300 = 16).
One of the advantages to use the DTG ratio is eliminating currencies out of equation. During the 20th century, money lost its property as being a ‘store of value’ and became currencies, used only as a medium of exchange, without any intrinsic value. Because currencies represent imaginary value, there is no limit to how much of a currency can be released into circulation. Therefore, currencies are subject to inflation, making them very volatile and an ideal tool for speculation.
DJIA is calculated based on stock prices of 30 major companies listed on New York Stock Exchange. Stocks have value because they represent shares of a company. The value behind the stock of a company is based on its ability to generate a profit on the physical assets owned and the labor provided by its employees. Whoever has stock in one company, is co-owner of the assets of that company.
Gold has intrinsic value due to rarity, durability, and desirability. It is a physical object that requires labor to be found, extracted and purified.
When calculating the DTG by eliminating the immaterial currency in between, we compare directly two asset classes that are both based on material substance and labor.
How to interpret the DTG Ratio?
When the DTG Ratio has high values, it means that stocks are evaluated higher than gold. These are times when investors are optimistic about the economic activity in general. They expect the companies to sell more, to increase revenues and profits, therefore they buy stocks. In these times, investors are willing to take risks. When more buyers come in, stock prices are moving higher. Gold is less attractive. DJIA increases and the gold price stagnates or even decreases, leading to a higher DTG.
When investors start losing optimism or when they feel that the stocks are over-evaluated, they start moving their money out of the stock market. More sellers lead to lower stock prices. As this process accelerates, the investors’ main focus is preservation; therefore, they look for ‘safe havens’ – and precious metals have been the ideal asset in this category. More gold buyers lead to higher gold prices. With lower stock prices and higher gold prices, the DTG ratio decreases.