Why Dow-to-Gold Ratio

Our analysis demonstrates that an investment strategy based on the Dow-to-Gold Ratio provides significantly better returns than any of the following strategies:

a) 100% gold allocation;

b) 100% stocks allocation (index);

c) Stock and cash portfolio (100% stocks allocation during bullish periods and 100% cash allocation during bearish periods).

The analysis is based on a 100 years evolution of DJIA and Gold price, from 1919 to March 2019 and assumes that an individual (or a group of individuals) would have invested $1,000. Further, the analysis would determine the return for each of the strategies listed above.

Starting point – year 1919

Before that, let’s see what represented $1,000 in 1919. Based on different statistical data available, this amount represented:

· one yearly salary for a highly skilled worker;

· about 50 ounces of gold;

· one new higher-end car;

· two new regular cars (Ford T was sold in 1919 for $500).

Strategy (a) - 100% gold allocation

The amount of $1,000 would have bought in 1919 approx. 50 ounces of gold. With a price of approx. $1,300 per oz. in March 2019, this amount of gold would have a value of around $65,000. This amount represents one-year salary of a highly skilled worker or professional service associate.

Although technological progress made car driving and transportation a completely different experience, the same amount ($65,000, or the value of 50 ounces of gold multiplied by $1,300 per ounce) would definitely make it possible to buy one new higher-end car or two new regular cars – at a price of $32,500 each.

Observing that 50 ounces of gold will buy the same goods over 100 years span, the conclusion is that gold, when kept over long time, serves as a very good preserver of value and purchasing power. This makes gold an ideal way to preserve wealth over long time, especially when it comes to transferring this wealth from one generation to another.

Strategy (b) - 100% stocks allocation (index)

This strategy is based on staying invested in a stock portfolio that resembles the DJIA index. Those who promote this ‘ride-the-index’ model, claim that stocks go up and stocks go down, but in the longer term, the return is always good.

The nominal return can be calculated based on the DJIA evolution from 1919 to 2019:

• in March 1919, the Dow Jones Index was 89. The $1,000 investment would represent the equivalent of 11.23 DJIA shares.

• in March 2019, with a DJIA standing at 25,500, the 11.23 DJIA shares would have a total value of $286,517.

• compared to the $1,000 that were the starting point, that is approx. 28.65 times increase in 100 years. The equivalent rate of return to achieve this increase would be 5.8% per year.

A return of 5.8% per year may seem like a nice return, but we should not forget that inflation eats a significant part of it. In order to calculate the rate of return in real terms, we can use three methods:

(1) Inflation adjustment

Using the calculator provided by US Inflation Calculator [https://www.usinflationcalculator.com], the total cumulative rate of inflation between 1919 and 2019 is 1361.1%. An item that was sold for $1 in 1919, would cost $14.61 in 2019. Therefore, while the nominal increase would be from $1,000 to $286,517 over the 100 years span, the increase in real terms would be from $14,610 to $286,517; that would be only 19.6 times. This represents an average yearly rate of return of 3.02% if we adjust for official inflation numbers.

(2) Average yearly salary

If we use the yearly salary as a basis, the $286,517 represents in 2019 roughly 5.5 yearly salaries, while the $1,000 represented one yearly salary in 1919. So, in terms of work income, the increase is just above five-fold, (or 550%), over 100 years. The equivalent rate of return to achieve this increase would be only 1.75% per year.

(3) Portfolio values expressed in gold ounces

If we evaluate the increase in terms of gold ounces, the $1,000 represented 50 oz. of gold in 1919. In 2019, with the gold price being at around $1,300 per ounce, the $286,517 represents around 220 ounces. The increase from 50 to 220 oz. would be 4.41 times, or 441%, over 100 years. The equivalent rate of return to achieve this increase would be only 1.5% per year.

Regardless the method we use, we can conclude that the ‘ride the index’ strategy would have produced a nominal rate of return of 5.9% per year, but the rate of return in real terms would be somewhere between 1.5 and 3% per year, depending if we measure it by the official inflation rate, increase in purchasing power or in ounces of gold.

Strategy (c) - 100% stocks allocation (index) during bull market runs combined with 100% cash allocation during bear market periods.

Assuming that it was possible to perfectly identify the peaks and troughs of the stock market, the funds would be invested in stocks until the market hit a high point. Then, when the peak was identified, the stocks would be sold and the cash resulting from the sale would be kept as long as the stock market was on the downside. Then, when the bottom is identified, the allocation would change from cash to stock.

The key moments (indicated in the graphs below, available at www.macrotrends.net) would be:

· 1919: initial investment [$1,000] and 100% allocation to stocks (index based)

· Aug 1929: sale of all stocks [DJIA at a peak point of 380] and move to cash

· June 1932: move to 100% index-based stocks portfolio [DJIA at a low point of 380]

· July 1937: sale of all stocks [DJIA at a peak point of 183] and move to cash

· April 1942: move to 100% index-based stocks portfolio [DJIA at a low point of 95]

· Jan 1966: sale of all stocks [DJIA at a peak point of 984] and move to cash

· Dec 1974: move to 100% index-based stocks portfolio [DJIA at a low point of 616]

· Aug 1987: sale of all stocks [DJIA at a peak point of 2,663] and move to cash

· Dec 1987: move to 100% index-based stocks portfolio [DJIA at a low point of 1,939]

· Dec 1999: sale of all stocks [DJIA at a peak point of 11,497] and move to cash

· Sep 2002: move to 100% index-based stocks portfolio [DJIA at a low point of 7,592]

· Oct 2007: sale of all stocks [DJIA at a peak point of 13,930] and move to cash

· Feb 2009: move to 100% index-based stocks portfolio [DJIA at a low point of 7,063]

· March 2019: currently, the DJIA is at a level of 25,500

In March 2019, the stock portfolio would have a value of $32,462,480.

The increase from $1,000 (in 1919) to $32,462,480 (in 2019) is equivalent to a nominal return rate of 10.9% for each of the 100 years.

The same observation can be made about nominal vs. real return. A return of 10.9% per year is an excellent rate of return, but inflation also needs to be accounted for. In order to calculate the rate of return in real terms, we can use the same three methods:

(1) Inflation adjustment

Using the calculator provided by US Inflation Calculator [https://www.usinflationcalculator.com], the total cumulative rate of inflation between 1919 and 2019 is 1361.1%. An item that was sold for $1 in 1919, would cost $14.61 in 2019. Therefore, while the nominal increase would be from $1,000 to $32,462,480 over the 100 years span, the increase in real terms would be from $14,610 to $32,462,480; that would be 2222 times. This represents an average yearly rate of return of 8.0% if we adjust for the official rate of inflation.

(2) Average yearly salary

The $32,462,480 represents in 2019 roughly 650 yearly salaries, while the $1,000 represented one yearly salary in 1919. So, in terms of purchasing power, the increase is 650 times. The equivalent rate of return to achieve this increase would be 6.69% per year. Still, a nice and significant return, but indeed below the 10.9% nominal.

(3) Portfolio values expressed in gold ounces

If we evaluate the increase in terms of gold ounces, the $1,000 represented 50 oz. of gold. In 2018, with the gold price at $1,300 per ounce, the $32,462,480 represents around 24,971 ounces. So, in terms of gold ounces, the increase would be 500 times over 100 years. The equivalent rate of return to achieve this increase would be only 6.41% per year.

Regardless the method we use, we can conclude that the ‘stocks and cash’ strategy would have produced a nominal rate of return of about 10.9% per year, but the rate of return in real terms would be somewhere between 6.4 and 8 % per year, depending if we measure it by the official inflation rate, increase in purchasing power or in ounces of gold.

The “Dow-to-Gold” Strategy

This strategy is based on following the trend shifts in the Dow-to-Gold ratio.

Assuming that it was possible to perfectly identify the peaks and troughs of the DTG Ratio, the funds would be invested in stocks as long as DTG ratio would be on an ascending trend. Then, when the peak was identified, the stocks would be sold and the cash resulting from the sale would be converted into gold and kept as long as the DTG ratio would be on a descending trend. Then, when the bottom is identified, the allocation would change back to stocks.

The 100-year chart below (1915 to 2019), available at Macrotrends (https://www.macrotrends.net/1378/dow-to-gold-ratio-100-year-historical-chart) illustrates very well these trend changes:

The corresponding peaks and troughs of this development are listed below:

· Mar 1919, DTG = 4.44

· Aug 1929, DTG = 18.36

· Feb 1933, DTG = 1.94

· Feb 1937, DTG = 5.35

· Apr 1942, DTG = 2.80

· Jan 1966, DTG = 27.85

· Dec 1974, DTG = 3.35

· Aug 1976, DTG = 8.87

· Jan 1980, DTG = 1.29

· Aug 1999, DTG = 42.19

· Aug 2011, DTG = 6.36

· Mar 2019, DTG = 19.84 (current value)

In 1919, the amount of $1,000 represented approx. one yearly salary for a highly skilled worker in industry. After 100 years of decisions based on DTG ratio and correctly identifying the peaks and troughs below, the investment portfolio would now be valued at almost 2 billion dollars ($1,982,504,831). This increase is equivalent to a 15.60% nominal rate for each of the 100 years.

The same observation can be made about nominal vs. real return. A return of 15.6% per year is indeed an excellent rate of return, but inflation also needs to be accounted for. In order to calculate the rate of return in real terms, we can use the same three methods:

(1) Inflation adjustment

Using the calculator provided by US Inflation Calculator [https://www.usinflationcalculator.com], the total cumulative rate of inflation between 1919 and 2019 is 1361.1%. An item that was sold for $1 in 1919, would cost $14.61 in 2019. Therefore, while the nominal increase would be from $1,000 to $1,982,504,831 over the 100 years span, the increase in real terms would be from $14,610 to $1,982,504,831; that would be 135,695 times. This represents an average yearly rate of return of 12.5% if we adjust for the official rate of inflation.

(2) Average yearly salary

Based on an average yearly salary of $50,000 in 2018 (high skilled worker in industry or construction, or a professional employee in a service-related position), in March 2019 the amount of $1,982,504,831 would represent no less than 39,650 yearly salaries! So, in terms of purchasing power, the increase is 39,650 times. The equivalent rate of return to achieve this increase would be 11.15% per year.

(3) Portfolio values expressed in gold ounces

If we evaluate the increase in terms of gold ounces, the $1,000 represented 50 oz. of gold. In 2019, with the gold price at $1,300 per ounce, the $1,982,504,831 would represent around 1,525,000 ounces (or around 47.2 Metric Tons of gold). So, in terms of gold ounces, the increase would be 30,500 times over 100 years. The equivalent rate of return to achieve this increase would be approx. 10.86% per year.

Regardless of the method we use, we can conclude that the ‘Dow-to-Gold’ strategy would have produced a nominal rate of return of about 15.6% per year, but the rate of return in real terms would be somewhere between 10.86 and 12.5 % per year, depending if we measure it by the official inflation rate, increase in purchasing power or in ounces of gold.

Why Dow-to-Gold – conclusions based on the past 100 years

The outcomes of the four different strategies applied to the past 100 years (March 1919 - March2019) can be summarized as following:

· Strategy (a) - 100% gold allocation is the best "purchase power preservation" strategy. The 50 ounces of gold purchased in 1919 with $1000 would represent the same income and buy basically the same goods 100 years later.

· Strategy (b) - 100% stocks allocation (index) for the entire 100 years period would have produced a nominal rate of return of 5.9% per year, but the rate of return in real terms would be somewhere between 1.5 and 3% per year, depending if we measure it by the official inflation rate, increase in purchasing power or in ounces of gold.

· Strategy (c) - 100% stocks allocation (index) during bull market runs combined with 100% cash allocation during bear market periods would have produced a nominal rate of return of about 10.9% per year, with a rate of return in real terms would be somewhere between 6.4 and 8 % per year, depending if we measure it by the official inflation rate, increase in purchasing power or in ounces of gold.

· The ‘Dow-to-Gold’ strategy would have produced a nominal rate of return of about 15.6% per year, with a rate of return in real terms somewhere between 10.86 and 12.5 % per year, depending if we measure it by the official inflation rate, increase in purchasing power or in ounces of gold.

The obvious conclusion is that the Dow-to-Gold strategy offers returns, both in nominal and real terms net superior to any other strategy. The main reason is, of course, the fact that this strategy allows for positioning on the bullish trend not only when stocks are favored, but also when investors are looking for safe havens and precious metals become the darlings of the market.

Why Dow-to-Gold – a look into the past and the future

Looking again at the 100 years Dow-to-Gold Ratio historical chart (below), the development is cyclical and we can easily identify three waves (marked A, B, and C), all three following a similar pattern, with four subsequent phases:

· First increase (strong)

· First decrease (strong)

· Second decrease (smaller than first phase)

· Second decrease - bringing the DTG to a new minimum.

Observing that Waves A and B completed all four phases and Wave C only three of the four phases, the legitimate questions are:

· Did the peak values of the Dow-to-Gold Ratio registered at the end of 2018 and beginning of 2019 represent the end of phase C3?

· Will we witness a phase C4, as the final phase of Wave C?

If the long-term cyclicality of the Dow-to-Gold Ratio is proven to be right, we can expect a fourth phase (C4) completing wave C. In this wave, the Dow-to-Gold Ratio will decrease from its peak (22.36 in Sept 2018) to a new minimum. This is shown in the next chart.

If this minimum aligns with the previous two minimums, (Apr 1942 at 2.80 and Jan 1980 at 1.29), we should not be surprised to experience a minimum of the Dow-to-Gold Ratio of about 1.00 or even lower.

What would be the scenario that makes the C4 phase possible?

With current levels of Dow-to-Gold Ratio in the range 18-20 (DJIA somewhere around 25-26,000 and spot gold around $1,250 – $1,300), it is hard to foresee this ratio going down all the way to 1.00. Still, this is possible in a circumstance where two factors occur at the same time: · on one hand, a financial crisis generates strong deflationary forces - debt cancellation and evaporation of derivative financial products, leading to stock market crashes. · on the other hand, loss of confidence in the existing financial system leads to a rush into safe haven assets, causing a significant rise in gold prices.

If this happens, this would be no different from the previous phases A4 (Feb 1937 - Apr 1942) and B4 (Aug 1976 - Jan 1980). In both circumstances, these two factors occurred simultaneously, although the reasons and conditions were different.

The phase A4, from Feb 1937 to Apr 1942, was a period when the economy went back into recession, a recession initiated first by fading away of the short-term boost generated by the artificial stimuli of the New Deal, followed by start of the WWII. During these years, the price of gold has been kept constant at a level of approx. $35 per ounce, a price that was kept at this level until the late ‘60s and early ‘70s, as part of the Bretton Woods Agreement. Since the gold price was constant, the 48% drop in the DTG from Feb 1937 to April 1942 is simply a reflection of the corresponding drop in DJIA (from 187 in Feb 1937 to 95 in April 1942).

The phase B4, from August 1976 to January 1980, was a period when the stock market did indeed experience a 22% correction (with DJIA dropping from approx. 1,000 in Aug 1976 to 875 in Jan 1980), but this correction was not the only factor causing the 85% drop in the Dow-to-Gold Ratio. In the same time frame, gold price increased from $110 per ounce (Aug 1976) to $678 (Jan 1980). The second half of the ‘70s were the years when the US economy experienced high inflation and low economic growth due to, among other reasons, the decision of the Nixon Administration to put an end to the Bretton Woods Agreement and cease the convertibility of the US Dollar into gold, decision implemented in 1971.

During the following years, the international confidence in the US Dollar was eroded to the level where the US Government was forced in 1978 to issue Treasury Bonds in Swiss Francs and Deutschmarks to prevent further fall of the US Dollar in relationship to other currencies (these bonds are known in the financial world as ‘Carter Bonds’).

Since circumstances proved to be very different for these two examples, 40 years apart from each other, the lesson to be learned is we may be able to look into the evolution of the Dow-to-Gold Ratio not only based on fundamentals (economical and geo-political events, monetary policies and general confidence in currencies), but also looking into cyclicality and repeatability of the ratio.

Given the observations made here, I personally believe that a phase where the Dow-to-Gold Ratio will register a downtrend towards a new minimum is not only possible, but imminent. My view is that, if this happens, it will lead to a significant wealth transfer; on one hand, those who keep most of their assets in stocks and stock related financial assets will register great losses, and those who hold precious metals (gold and silver) will register major gains. The imminence of a such next phase prompted us to investigate the possibility to identify a method that allows us to determine a trend change. In order to find out more about this method, please click below.

Find out more about our method