What if the next Kondratieff Winter phase causes the Dow/Gold ratio to correct to a long-term average? What would then happen to the DJIA or the price of gold? Fitting a linear regression line to the data between 1896 and 2001 gives a line with a slope of 0.1511 increase per year in the ratio. This puts the long-term average ratio at about 17 in 2002. The last period for which the ratio was below the regression line was 1973 to 1995, when the average ratio was 5.54 over the period.
"Looking at the chart, the long term trend of the ratio is up at a rate of 1.25% per year. This should be expected as the process of mining gold becomes more efficient and cheaper due to advances in machinery, energy, exploration technology, chemicals, etc. In fact, the advances in mining probably match the efficiency gains seen in the economy in general."
Long Term Dow/Gold Ratio [Fred's Intelligent Bear Site]
We can now predict what the Dow and the price of gold would be, assuming they both change by the same proportion (i.e. Dow falls to a certain fraction of its bubble value, and gold rises by the same proportion).
If the ratio falls to the value that it had in the last low period, then the Dow will be 3934 and gold will be $710. Even if we only assume a fall to the trend line, the result is a Dow of 6889 or a gold price of $405. Of course, for the long term trend to hold, the ratio by the law of averages must correct for its time above the trend by a corresponding time below the trend.
We can also look at what might happen if either Gold or the Dow stays roughly the same, but either the Dow falls or gold rises to revert to the trend.
If we assume that gold stays at about the level of the 2001 close, i.e. $278.7, this predicts a Dow that will fall to 1544. If we assume that the Dow stays at about the level of the 2001 close at 10021.5, this predicts a gold price of $1808. Even if we only assume a fall to the trend line, the result is a Dow of 4734 or a gold price of $590.
The bottom channel line of the long-term inflation-adjusted DJIA suggests a potential Dow fall to around 2-3000:
Dow Jones Industrial Average Inflation Adjusted [Fred's Intelligent Bear Site]
So, whatever happens, when the Dow/Gold ratio crosses over its long term trend, and the Kondratieff cycle gives us a clue as to when that might happen, there must surely be major consequences in the markets. |
