Generational Cycles in the Dow/Gold Ratio

The endeavor of speculating in financial markets is shrouded in confusion, fierce debate and  — often — mysticism. Here at, we’re at least a little bit guilty of succumbing to the latter. The long-term trends in financial assets seem to follow generational cycles. This is particularly evident in the gold price of the Dow Jones Industrial Average.


Dow Gold Ratio Generational Cycle

Click to enlarge. Source: World Gold Council & Yahoo Finance - This chart is updated every week on the 'Long-Term Charts' Page


Hey! Stop Pricing the Dow in Gold, you #@!%!


I am sure that many people are fuming because I had the audacity of calculate & chart this ratio. So, just to get things clear, I thought I’d address the reasons behind using it before anything else. To demonstrate why this is a legitimate means of analysis, I’ll have to go over the history of the dollar briefly.


Prior to 1933-34, the dollar was on the ‘Classical Gold Standard’. Meaning, dollars were redeemable into gold at the rate of around $20 per ounce. In this way, the Dow was effectively priced in gold (that is, the Dow traded with dollars — which were defined as $20.67 an ounce). After the unpalatable circumstances of 1929-1934, the dollar was debased to $35 per ounce (i.e. instead of requiring $20 to get one ounce of gold, one required $35). Moreover, public ownership of gold was banned, and redemption claims were made the exclusive privilege of world governments and central banks. So, from 1934 onwards, governments and central banks were half-heartedly engaged in ‘defending’ their currencies against gold at the decreed rates. In this way, the Dow was essentially priced in gold (that is the Dow traded with dollars – which governments attempted to keep at specific rates against gold  - $35 an ounce). However, by the late 1960s / early 1970s, it became clear that the quantity of gold backing the outstanding quantity of dollars was insufficient. So, as the resultant circumstances were deemed to be unpalatable (after all, who likes dealing with an angry Frenchman with a battleship), the dollar was debased again (to around $42 an ounce) and unequivocally unleashed from gold.


Now, I use the term ‘unleashed’ because gold is still a major component of the World’s monetary assets. That is, gold still ‘backs’ dollars, Swiss francs, Yen, Pounds not-so-sterling (etc.) but not at a specific rate. The World’s governments and central banks have given up the task of ‘defending’ their currencies against gold, and so those currencies are free to depreciate indefinitely against gold.


As I often say here on, Fiat Currencies trade at ‘Discounts to Par’. Meaning, the structure of fiat currency prices of central banking assets (gold, govt. bonds, MBSs etc.) should reflect the fact that dollars etc. are at most as good as what backs them. Consequently, central bank balance sheet expansions are dilutive, and currencies can be debased to suit the balance sheets of certain ‘systemic’ institutions.


The important point is that the dollar of 1971 is entirely different to that of 2011! Even, the dollar of last week is different to the dollar of this week! As the central banks of the world change the sizes and compositions of their respective balance sheets, outstanding dollars, euros and pounds (etc.) become (different) irredeemable claims upon different sets of assets. Hence, it is inappropriate to measure long-term price trends in terms of these ‘unleashed’ fiat currencies.


It is quite conceivable to me that the above is unconvincing to some. So, to really hammer the point home, let me ask you a question: If I plotted a chart of the US Government bond price of the Dow from 2000 to 2007 and then changed the line to a MBS price of the Dow from 2007 to 2011, would you call me crazy? Well, that is — roughly speaking — what one is doing when plots a chart of the Dow priced in dollars! [See chart below]


Federal Reserve Balance Sheet Chart (Proportional)

Click to enlarge. Source: Federal Reserve


Therefore, to understand the progression of valuations through time, it makes sense to measure the Dow Jones (a proxy for the valuations of US prime-productive output) in terms of gold. By doing so, we can reasonably compare the progression of these financial assets over a 100-year period. Indeed, looking at the chart above, this seems to be corroborated – the range of the Dow priced in gold these days is not outrageously different to the range 90 years ago.


But, but, but … the ratio only does that because gold ‘increases in value’!


I should remind you that the dollar price of anything, as well as the egg price of milk, the beef price of Ferrari’s, the shaving cream price of oranges and so on… are all subject to this trait. That is, the trait that all prices are exchange ratios between two things – i.e. the rates at which people swap stuff. Financial markets are arenas where people swap stuff for dollars, so symmetry surely does pervade them. The dollar price of a thing is as much about dollars as it is about the thing. Hence why has such a keen focus on money – we operate under the premise that long-term success in financial speculation is contingent on a solid understanding of this fact. The result is that one should spend as much time on monetary trends as one does on trends in things.


So, spelling it out, when we say that gold ‘increases in value’, we should note that gold increases against dollars. It is as much about dollars as it is about gold.


The Generational Cycle:


So, let’s address the pertinent question: Why should it be the case that financial markets move in generational cycles? Why should each generation be bound to repeat the follies of their fathers?


As Robert Prechter often reiterates, the financial markets are a peculiar field. Unlike consumption goods & services, we do not have personal utility for the things that we purchase. We have no internal gauge when it comes to financial speculation, rather, we are executing with the hope that someone else will want it more (again for speculative reasons). So, in this way, we’re trying to anticipate the anticipator. This is an incredible task, because we are trying to do something that is contingent on someone else’s view, and yet we only have our own lenses with which to view reality. So, naturally, financial markets are surrounded by confusion and tentativeness. With this inescapable context of operation, we – in aggregate – are suckers for the respectability of something ‘that works’. This requires the passage of a long period of time where the trend remains intact. It would seem that a bullish price trend (in the Dow versus gold) becomes extended after a generation have ‘grown up’ with it (around 20-25 years). Or, if you will, a generation has found that a bullish price trend is a ‘normal operating environment’. Likewise, the bearish price trends – that is, the undoing and refutation of our aggregate premises – takes 15 years to reach the depths of apathy and distaste for speculation.


Current Context & Positioning:


Currently, we’re around 11 years into a bear market in the Dow Jones vis-a-vis gold. Moreover, it would seem that we have a reasonable way to go: it still takes roughly 8 ounces of gold to purchase the Dow Jones Industrial Average. Typically, the bottom would be characterized by a Dow/Gold ratio of 1-3. So, although the contrarian asymmetry has gone, the trend seems to be intact, and could easily remain intact for another 3-5 years.


If one believes in the above interpretation (as I do), then it would make sense for one to have a portfolio that revolves around being long gold and short stocks (in whichever way may be appropriate to ones sensibilities). Fortunately, this also means that we have a fantastic opportunity in the not-too-distant future. As Russell Napier said in a recent interview with the FT (paraphrasing as the link is broken for now):


Remember, these are great opportunities to buy for a generation. If you buy near these bottoms, you can literally go to the beach for the next 20 years…


Meddling With Money:


As can be seen on the Dow/Gold chart at the top of the article. The depths of bear markets typically bring about some kind of meddling with money. In 1933-34, the consensual opinion was that ‘gold speculators’ and ‘gold hoarders’ were causing the nation’s pain and that their actions were decidedly ‘unpatriotic’. The result was a series of ‘bank holidays’ and a resultant debasement and expulsion of gold from public eyes. In the late 1960s / early 1970s, the consensual opinion was that the Bretton Woods system lacked the flexibility of freely-fluctuating rates. And that gold speculators were unpatriotically driving up the dollar price of gold in excess of the decreed rate. The result was a series of frivolous monetary agreements that lead to the full unleashing of the dollar from gold.


So, if we continue to see a fall in the gold price of stocks (that is, an appreciation of gold against stocks), the concomitant finger pointing could lead to another round of meddling with money.


Be a Lover Not A Fighter:


The price trend shown on the above chart is blindingly clear. Moreover, it is — quite frankly  — well developed. This means that the asymmetry (i.e. favorable risk reward profile), is diminished, however, the trend remains in force. There seems to be a few years to go, so I would strongly suggest that you embrace it while it remains (and before the risk/reward profile becomes unfavorable).


After the plethora of bubbles over the past decades, it is unsurprising that people are watching for bubbles like crazy, but it doesn’t matter. Gold is still wholly ‘underowned’ (see chart below), and stocks are still the instruments that people think they’ll retire on.


Gold_in_Pensions Portfolios

Click to enlarge. Source: Casey Research




The bear market in the Dow vis-a-vis gold is still underway, and may continue to be underway for a few years to come. Fortunately, there may be a fantastic generational opportunity coming up in the not-too-distant future. I keep the Dow/Gold charts on the ‘Long-Term charts‘ page (along with some other great charts). I update it every week, so feel free to bookmark it and come back every once in a while to check its progress. Hopefully this will help you with your investments over the coming weeks, months, years and decades!


Alternatively, if you’d like to hear what we’ve got to say on a more frequent basis, then you might want to ‘follow’ and/or subscribe (see buttons in the top right of the window). Moreover, if you’re interested in our thoughts on the practicalities of month-by-month portfolio positioning, you might want to subscribe to our monthly newsletter. I assure you, we will eventually get bullish here on In the meanwhile, it’ll pay to be patient, prudent and ever-watchful!

See here for our collection of rare historical economic data.

Posted Jun 17, 2011
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  • Toby

    Just discovered your site today and am thrilled by the huge store of graphical data.
    I’m not so sure I agree with all your conclusions though. Since a gold standard requires accepting gold in exchange for money interchangeably, a trade deficit requires a steady outflow of gold to buy back the dollars spent on the deficit. Thus, theoretically for all countries to prosper, trade must be perfectily balanced or average out. The problem is amplified by the leverage ratio of money to gold. Are you in favor of a money multiplier of one? Islamic banking is unpopular even in Islamic countries.

    Why can’t money be a valueless bucket in which to exchange value? That allows for growth to match value creation. Having a growing world economy requires a growing volume of money, since the growing exonomy requires more money and the economic cycle requires varying amounts of money.

    I ran across a graph of commodities priced in gold which I have been unable to locate again, but price whipsaws were twice as bad as when commodities were priced in currency.

    Just a few things off the top of my head this morning.


    • Greshamslawcom

      Thanks for your kind words Toby.

      “a trade deficit requires a steady outflow of gold to buy back the dollars spent on the deficit. Thus, theoretically for all countries to prosper, trade must be perfectily balanced or average out.”

      Assuming that outflows of gold are ‘bad’ – that is not the case – outflows are just… outflows.

      “Why can’t money be a valueless bucket in which to exchange value? That allows for growth to match value creation.”

      Who will take it in exchange for stuff?

      “but price whipsaws were twice as bad as when commodities were priced in currency.”

      Again – price whipsaws aren’t really ‘bad’ either -> they’re just… whipsaws

  • Jonathan

    But Gold doesn’t glimmer like it used to. The fact is fiat currencies have value because we use them. If you indulge in business to gain profit you create tax liabilities. Those tax liabilities are due to world governments in fiat currencies. Going back generations to when income tax was peanuts, currencies needed backing by something, otherwise no-one would want them. Now, we have no choice but to operate in world currencies. You as an American try to establish a barter business or a business that only accepts payment in silver coins. The feds will be after you for your tax IN DOLLARS within the year.