After spending the last month consolidating (around 8:1) the Dow/gold ratio broke down on Friday to close at 7.47. This is a major shift, as the upward trend line in favour of the Dow since September has been broken with a significant drop. This is a significant event that should trigger the selling of the boarder equity sector as money moves out of the Dow and S&P and into gold and related equities. Gold has once again become a safe haven as uncertainties around the Euro and fiat paper currencies persist. In addition, the growing consensus of a global economic slowdown and possibly a recession in the U.S. in the coming quarters, is bullish for gold.
Gold is on the rise, especially compared to the Dow, as we move from a 7.5 ratio (Dow at 12,000 and gold at $1600) towards a 5:1 ratio and lower in the coming year. Within a few years, we wouldn't be surprised to see a Dow to Gold ratio of 1:1. History tells us that this ratio should be revisited again in the coming years. If the longer term chart of the Dow/gold ratio is any indication of how quickly it will happen, it will be sooner rather than later. If you are invested in the broader stock market or mutual funds, this is the time to act and protect your wealth. Once the final waterfall on the Dow develops and gold begins rising, it can move very quickly. By all indications on the charts and given the current market conditions, we believe it has already started.
How Do We Reach the DOW/GOLD Ratio of 1:1?
The Inflationary Path
With the Dow now slightly above 12,000 and gold around $1620, the ratio is contracting fast as we move towards and below 5:1 in the coming years. How this will manifest itself is anyone's guess at the moment. If the Dow remains at 12,000, in an inflationary environment, gold will gravitate towards to the 1:1 ratio as it moves to a fair market value based on the outstanding debts and currency units floating around in the system. In the coming years, if the central bankers continue the path of papering over the financial mess that they have created, gold can easily reach $10K+. During a currency event, gold could climb to that price objective and it will take silver along with it. If we return to the historical gold/silver ratio of 15:1, we could easily see silver at over $650 per ounce. Silver has been trading at around 55:1, and a currency event could move it towards the 15:1 ratio. At today's price, silver has a lot of upside compared to gold.
A deflationary spiral that unwinds debt around the world and leads to revaluationsof paper currencies could also be in the cards. The unravelling of the Euro couldcause just such an environment. In this case, central bankers will not be ableto stop the deflationary spiral that ensues as individuals start opting out ofthe paper/debt based system. The bankers are pulling out all the stops and printingendless amounts of money to prevent this, but psychological forces can easilyoverwhelm this; economic law has a way of correcting imbalances created by man.Under this scenario, the Dow will crash in a deflationary spiral towards gold'sprice and possibly meet somewhere in the middle or at the lower end of gold'strading range.
The Deflationary Path
Watch For 1:1
Either way, history has shown us that we are moving towards a long term cycle of low stock prices and higher gold prices; this should play out in the next few years, as it has already has started. Trying to predict the price of gold is futile, what is most important is the Dow/gold ratio if 1:1. Once we reach that objective or close to it, it will be time to get out of gold and move to other undervalued asset classes such as the Dow, until then stay long gold and short the Dow.
Once a trend based on fundamentals is in motion, it is very difficult to stop, as much as the masters of the paper universe would like to maintain control. If a loss in confidence by the population of the world in purchasing power of fiat currency and the value of the assets based on that paper price starts, (something we think has already started) then the there is no stopping this trend. All the bankers can do is try and maintain the illusion of control, but eventually their efforts will fail. The gold market senses this. As a result gold and gold related equities will outperform every other paper market and asset class moving forward for the next few years. The price action on June 1, 2012 is just the beginning for the golden days ahead; just make sure your financial survival kit contains a percentage of gold, it may be the only thing that maintains its value as the paper currencies and paper assets around the world devalue compared to gold.
Strategy For Hedging Your Paper Assets
Many of our readers already have a long position in physical gold and positions in several key mining companies and juniors. We have kept a core position in the gold sector and will continue to add on additional weakness. We are also evaluating potential gold producers and precious metals juniors/explorers which will have significant upside in the coming years as the nominal value of gold rises compared to other asset classes.
If you are not invested or protected in gold, now is a perfect time to start adding to your position. You will need to protect your wealth and purchasing power in the coming years and gold will help you to achieve this goal. Unfortunately, 99% of the population is not protected by having a golden hedge. Most people have their retirement savings or other assets based on what the establishment has guided them towards. That is, general equities in broader indexes. This strategy will most likely not protect your wealth or purchasing power unless you take actions to diversify and create a hedge against a failing paper based asset pricing mechanism.
Last week we suggested subscribers look at options for hedging or going short the broader index. We are currently looking at additional options for creating hedges or going short the general equity markets. While we maintain our long gold positions, going short or buying ETFs that trade inversely to the broader markets may be a great strategy if you are still long these markets. Any additional strength in the broader markets (especially if there is an additional QE announcement) should see some significant resistance at the recent highs and that is when we want to get positioned on the short side of the broader market. For now, being long gold and out of the general equities may be a great trade going into elections and into early next year.
If you are looking for ideas and strategies for protecting your wealth and trading opportunities in the precious metals sector, please visit our site and sign up for our regular updates and blog posts. We regularly provide technical analysis on the price of gold and the HUI index which can help you identify good entry and exit points for trading.