COMMODITIES v. THE DOW
By John Myers
Commodities and stocks are both rallying together... What's wrong with this picture?
Since March of this year, the Dow Jones Industrial Average -- that venerable symbol of American wealth -- has increased from 7,500 to its current level of more than 9,400. That's a gain of 25%... and more importantly, it marks the first major up-trend since 2000.
Meanwhile, gold has rallied a whopping 48% since hitting a low of $252 in 1999. As we go to press, gold is at $378 an ounce. And the XAU Index of gold stocks is hitting a fresh six-year high.
The funny thing is, gold and the stock market typically head in opposite directions, not the same direction. What gives? And which market is "right?"
Which of the two is in a primary bull market? And where do investors turn to pocket profits today?
The dollar has tumbled this year -- down 5% against the euro since January -- but the price of gold, typically a vote of no-confidence in the greenback and overall economy, remains in a primary bull market.
Whether Wall Street will admit it or not, significant inflation is rolling in like a massive rogue wave. When it will crash ashore can be debated, but that it will hit eventually cannot be in doubt. Let's look at the evidence. MZM, the U.S. money supply that is M2 minus small-denomination time deposits, plus institutional money market mutual funds, has grown from $4 trillion in 1999 to nearly $6.3 trillion at the halfway mark of this year. That is a rise of nearly 60% in just four and a half years. To look at it another way, it took from 1987 to 1999 for MZM to rise from $2 trillion to $4.1 trillion. In other words, MZM has grown faster in the past four and a half years than the prior thirteen!
It is a similar story for the adjusted monetary base, or the super money that the Fed lends to banks, who in turn lend it out in multiples. The surplus cash key component of the adjusted monetary base is rising at an even more alarming pace than during the tough stagflation of the 1970s.
So with all this, there's good reason to wonder what the heck is going on in the markets.
Clearly we have a situation where both the stock market and gold are appreciating. Yet everything we know about these two markets tells us that the convergence in trends will not continue. Therefore we have to ask ourselves, which is a better bet, the stock market or the gold market? A recollection of the 1970s, a decade in which the price of gold rose 20-fold while the stock market stagnated, is worthwhile.
In 1966, one year after the U.S. government eliminated silver from quarters and dimes, the price of silver was $1.30 per ounce, the same price that silver had traded at in 1919. The stability in the price of silver to a large part reflected the sustained purchasing power of the greenback throughout the first two-thirds of the 20th century. But inflation would change everything.
Between 1970 and 1981, M2 money supply tripled! A then-record amount of liquidity was being injected into the economy each year. But all this money wasn't helping an economy that was just limping along. From the beginning of 1971 to the end of 1979, GDP rose by just one-third -- from $3.9 trillion to $5.2 trillion (in constant 1996 dollars).
As the amount of money in the economy vastly exceeded the goods and services being produced, inflation was inevitable. Consumer prices during the decade rose by a staggering 6.5% per year. By 1980 that 1970 dollar you had tucked away in your mattress would buy just 52 cents worth of goods and services.
Meanwhile, stocks traded sideways for more than a decade. In January 1966, the Dow breached 1,000 for the first time. Fourteen years later, the benchmark index was selling for only 759. After factoring in inflation from 1966 to 1980, the Dow price of 759 was actually worth only 329 in 1966 dollars.
Imagine, in real terms the Dow had lost two-thirds of its value in fourteen years. Ouch!
Clearly, the same inflationary trend that boosted the gold price was devastating for equities. And now, here we go again, as a new inflationary trend gets under way. In these early days, stock market investors don't care about "a little inflation." So stocks rally alongside gold. But the lion does not often lie down with the lamb. As the new inflation takes hold, stocks will suffer and gold will thrive.
It's just the beginning, folks... It's just the beginning.
We are seeing the early stages of a primary bull market in gold and other commodities. If this plays out as I suspect it will, the equities market is in for a period of many years where stock prices move sideways, and investors lose money primarily because of the decline in the purchasing power of their investment.
On the other hand, gold has demonstrated for over 2,000 years that it has a built-in premium to inflation. Thus, bullion rises at a greater rate than the currency that underpins the economic system.
The bottom line is that the real primary bull market is in commodities, especially in gold. My expectation is for its price to reach $800 per ounce before the end of the decade, and I am probably being too conservative at that.
Regards,
John Myers,
for The Daily Reckoning |
