December 14th, 2011

The S&P 500/Gold Ratio

On Wednesdays, the focus here at the Stock Chartist blog is on individual stocks or ETFs and the topic today is GLD.  GLD is the 2nd-highest capitalized ETF behind only SPY; it’s nearly triple the capitalization of QQQ. Some can look at the price of gold in purely economic terms to arrive at what they feel is a theoretically correct price; others attempt to correlate the gold prices to other assets to see whether they are in line in a macro- way and, finally, one can look gold prices in purely technical terms.

  • Some say that the price of gold has a fixed relationship to the rate of inflation.  Specifically, Eddy Elfenbein has estimated that relationship to be that “for every one percentage point that real rates differ from 2%, gold moves by eight times that amount per year.  So if the real rates are at 1%, gold will move up at an 8% annualized rate. If real rates are at 0%, then gold will move up at a 16% rate (that’s been about the story for the past decade). Conversely, if the real rate jumps to 3%, then gold will drop at an 8% rate.”
  • The stock market, as represented by the S&P 500 Index fluctuates within a fairly wide range when priced in gold rather than the $US.  I wrote about this last May in which a inserted the following chart (since updated) which shows the S&P 500/gold: S&P/Gold Ratio since 1971

“The ratio is a function of both variables, the price of gold and the value of the 500 largest US public companies. Both variables are equally driven by value of the $US, domestic and international economic trends and a host of other drivers. Alternative possibilities for the ratio are possible through almost an infinite number of combinations of both variables. Some gold bugs claim that the price of gold is headed to the $4000/ounce level without indicating what they think will happen to the stock market. That doesn’t work for me.Make your own guess as to where and when you think the price of gold will be. But you should also forecast where you think the S&P 500 might be at the same time. It’s only after you calculate their ratio and see where it plots on the above chart will you be able to assess the reasonableness of those projections.Once a long-term trend begins it’s hard to reverse. I can accept $4000 gold and the S&P hits 2000 (a 50% increase from current levels) for a ratio 2.0 in 2014.”

  • The charting approach is to look for reversals in the chart of the GLD etf (click on image to enlarge):

Everyone continually is on the look out for the big reversal, the one that will carry GLD back below 100 and gold below 1000.  Let me tell you with a high degree of confidence and certainty that a move as substantial as GLD has had since 2006, a reversal when it comes won’t happen in a week or month.  It’ll take quarters.  In the meanwhile, retracements like the many that occurred since 2006 and are plainly visible on the above chart, are only pauses in a long march higher.

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