Do the markets live in a fantasy world? Well no, the level the markets are trading at any point in time is what it is. But those levels are what is known as the nominal price for the market. That is what is reported every day. Therefore, when the markets move to new (nominal) all-time highs the "talking heads" become very excitable and repeat incessantly that the markets have made new all-time highs. What they usually fail to tell everyone is that while the markets have made new all-time highs (nominal) they are somewhat detached from reality.

So what is the problem here? The markets are making new all-time highs (nominal). It should be a time for celebration. The reality is, it is not. The markets appear to be detached from reality. Yes corporate profits are at record levels and the corporations are sitting on a "mountain" of cash. Price earnings ratios are not high certainly by what was seen at the market peak in 2000 although on an historical basis PE could be considered high.

On the other side unemployment remains high on a headline basis and when one considers long term unemployment in both Canada and the US the unemployment rate is in the mid-teens. Unemployment in the Euro zone is quite high and countries like Spain, Greece and Portugal are in depressions with official unemployment in the 25% range and youth unemployment over 50%. Yet the Euro zone stock markets are also in new all-time high territory.

In the US, some 45 million Americans are on food stamps and are considered to be living in poverty. That is upwards of 15% of the population. Average median household income has been falling for the past decade even following a small rise from 2004 to 2007. Income inequality has been growing not receding even as the economy appears to be coming out of the 2008-2009 recession. Consumer sentiment remains well below the highs of 2007 and well below levels seen in the 1990's. Growth in retail sales has remained statistically insignificant when one takes population growth into account.

If inflation and GDP were calculated as they were back in the 1980's and early 1990's the numbers would be higher. Inflation, currently reported as under 2% would actually be closer to 5% if reported as it was calculated in 1990 and over 9% if calculated as it was in 1980. The US economy has been in a recession since the beginning of the millennium. Q1 2013 GDP was reported as a gain of 1.8% but according to www.shadowstats.com GDP growth was actually negative 2%. GDP is calculated by Shadow Stats based on methodologies used back in the 1980's and before substantial changes were made.

Since the financial crash of 2008 the western economies (US, Euro zone and Japan) have been using quantitative easing (QE). QE is not new. It was also used extensively in the 1930's. Japan has been using forms of QE for over a decade. But when one looks at the velocity of money and the money multiplier the money is not getting into the broader economy. But it is getting into the stock markets largely through the large money center banks that are the major beneficiaries of QE. Rising stock market valuations help the money center banks balance sheets. It is believed for the US at least that QE is primarily to help prop up the banking systems in the US, the Euro zone and Japan. The banking system remains saddled with huge amounts of debt that is either toxic or uncollectable.

The chart below shows the US Indices on a nominal basis (to April 30, 2013). On a nominal basis both the Dow Jones Industrials (DJI) and the S&P 500 have seen meagre gains since their 2000 peak. The NASDAQ remains 34.1% below its 2000 peak.

Source: www.dshort.com

The chart below could be called the US stock market indices "reality" chart. It shows the indices adjusted for the rate of inflation (the official headline inflation rate not the inflation rate of www.shadowstats.com). Adjusting the stock market indices for inflation paints a very different picture. It is also a picture that is not generally reported. The DJI is in real terms down 7.1% from its 2000 high, the S&P 500 is down 23.3% and the NASDAQ is down 51.6% from their 2000 highs. The numbers above are to April 30, 2013 only. The US stock market has improved further in May 2013. However, things could be worse. The Tokyo Nikkei Dow is down 63.6% in nominal terms from its early 1990 highs.

Even if one included dividends, the S&P 500 is down about 3% from its 2000 peak. For most, reality is where the stock market is today. Reality, however, can be illusionary. The markets are not acting much different than they did during the 1970's. During that period the stock market traded in a broad range but on an inflation adjusted basis the market was falling. At the stock market lows of August 1982 the DJI was trading in inflation adjusted terms at levels seen back in the 1940's.

Source: www.dshort.com

What about gold? Gold was trading at multi-year lows back in 2000 when the DJI, the S&P 500 and the NASDAQ were making all-time highs. But gold in nominal terms despite the recent set back remains up 370% in nominal terms and up 270% in inflation adjusted terms. While gold is up 73% from its nominal high of 1980 in inflation adjusted terms gold is down over 40%. If one goes all the way back to August 1971 when Richard Nixon took the world off of the gold standard gold is up about 520% in inflation adjusted terms. The S&P 500? It is up roughly 175% in the same time period in inflation adjusted terms. And that includes the long years when gold underperformed.

Below is a very long-term chart of gold adjusted for the CPI. A few things stand out on the chart. Gold prices for years were fixed. Gold only broke out of its long channel once it was set free to find its market level. Major lows in gold prices on an inflation-adjusted basis were seen during the American revolution, the War of 1812, the US civil war, WW1 and the Vietnam War. The last major low was in 1999-2001 following years of low gold prices. Overall gold has proven over time to be an excellent hedge against inflation and a long-term store of value. However, there are periods to own gold and periods not to own gold. Despite the recent setback, the reasons to hold gold have not abated.

Source: www.sharelynx.com