December 17th, 2008

DJIA/Gold Ratio and the MTA

I’d like to tell you about somethings I heard last night while attending the first of what I hope will be many meetings of the Market Technicians Association (click here for more information about the MTA and their CMT, Certified Market Technician accreditation):

  • Because of the method used to calculate the Dow Jones Industrial Average, each $1 move by any of the 30 stocks results in an 8 point move in the DJ-30 Index. Therefore, if each of the thirty stocks go up one dollar then the Index increases 240 points.
  • The speaker, Alan Shaw, one of the founding members and past presidents, opined that today’s market and economy was more akin the the 1930’s than the 1970’s in that there’s currently price deflation rather than inflation, bank failures, low interest rates and eroding value of $US. As far as stocks are concerned, there could be a long period of correction (to 2018!) before stock indexes will again make new highs.
  • Wall Street firms, in their attempt to adjust to the market crash, have cut back their technical departments, rather than their fundamental analysis departments. It seems strange because fundamental analysis is less effective when the market is vacillating in a trading range rather then in a bull market trend.
  • “The trend is your friend”. Sell in a down market and buy in an up market.
  • A technical indicator some look at is the DJIA/Gold ratio. The very long-term average is around 10 (DJIA being 10 times more valuable than an ounce of gold). But according to a reference in The Big Picture blog of April, 2006, the following chart shows “periods of Dow/Gold ratio. The first two bold blue lines highlight the 14-year periods when gold outperformed the DJIA (1928-1942 and 1965–1979). The current third bold line shows that gold has been outperforming the DJIA since 1999”, implying that back in April, 2006, the price of gold would have to go up, the DJIA would come down or some combination of both. In fact, a little of both did happen.That ratio today is 10.19 (8850/872). If the ratio again overshoots to around 5, as it did in the previous two major adjustments then, still, the price of gold will increase, the DJIA will decline further, or both. My guess is that most of the adjustment will come through increases in the price of gold (Note: if the DJIA holds in the 9000-10000 range, gold would increase to 1800-2000 from the current 872 for the ratio to again drop to 5).

Many more interesting topics were discussed including the merits of the oldest form of charting — point-and-figure charts. But one key point I came away with is that whenever technicians evaluate a stock or the market they don’t do so in a vacuum; they do so with a mindset. We may think that charts, indicators, or any other quantitative measures neutralize and insulate us from subjective influences. In fact, (especially) when we look at something as objective as a chart, we do so with a mindset influenced by our personal biases. We need to always understand and keep in front of us this bias so as not to let them get in the way of a fair evaluation and decision.

Subscribe below or click here to learn more about help for navigating turbulent markets.