An Overview of the Gold and Stock Markets in the Autumn of 1998

August 24, 1998

Many gold market observers and participants have marveled at the gold price action over the last few years, feeling it has defied any rational explanation. That feeling is easy to understand when the facts are observed in historical perspective. The purpose of this overview, is to try to bring some perspective to the current gold market and to hopefully explain why the market has performed as it has in recent years. Although this overview will largely stand alone, it will be best understood if the reader will take the time to read the two previous articles by the author posted on this website, either now or after you have read this article. The two previous articles are Monetary Gold Mismanagement in the Twentieth Century, and A Possible Gold Price Scenario 1998 - ??.

We are going to use the chart which accompanies this article to help us understand both the current state of the gold market as well as the stock market. This chart (please note it is logarithmic scale) is both simple in its construction and in the relationship it depicts between gold prices and a financial asset, the Dow Jones Industrial Average. It shows a time series from the late 1800's to the present time for the number of ounces of gold needed to purchase one unit of the DJIA. This simple and straightforward chart provides us with many important insights into these complex markets. What are some of these insights?

Chart courtesy of Topline Investment Graphics

First it clearly shows that there are cycles in the relationship between gold prices and the value of the stock market as represented by the DJIA. We can easily see that there have been six turning points in this relationship between the stock market and gold prices during the last hundred years. It is evident that the cycle lengths are irregular, so we can not gain any timing insight from cycle length. We can observe, however, that the cycle length has been shorter in recent years, probably due to the accelerating pace of information flow in recent years. We should also observe that once a new cycle starts, it tends to last for many years. This makes the recognition of a turning point of great importance if an investor is to correctly choose the best investment vehicle and to know whether to be a bull or bear in that market.

When we examine the three bottom turning points on the chart, we see that they come when the ratio is in the one to two ounces of gold range. This means that it only takes one or two ounces of gold to buy one unit of the DJIA. This more importantly means that gold prices are very high relative to stock prices, and suggests a prudent investor would sell his gold and purchase suitable stocks which fit his investment objectives.

When we examine the top three turning points, we obviously see that the opposite condition exists, where it takes a relatively large number of ounces of gold to buy one unit of the DJIA. In 1998 we see that it took roughly 30 ounces of gold to buy one unit of the DJIA, which is the largest number recorded so far in the last hundred years. This is another indication of just how overextended this stock bull market has become. We now come to a crucial observation which can be extracted from this chart. Namely, that the evidence appears overwhelmingly to suggest that we are in a turning point in the relationship between stock prices (paper assets) and gold prices (real assets). If this is correct, then we should see stock prices fall and gold prices rise for the next few years at least.

Why is it taking so long for these trends to begin, and why have stock prices risen to what appears to be bubble highs while gold has dropped to what appears to many gold advocates to be bargain levels? Good questions all, which we will now explore in the following paragraphs.

As we go through the following discussion, please keep in mind that we are at or near a turning point in the relationship between two asset classes, which will be the culmination of an almost 20 year trend where stock assets (paper) have been dominant over gold (real assets). If we study the market history in the years surrounding these turning points, we find that the markets were in a great state of flux and turmoil, which is a logical expectation. It is exactly what we see happening today.

Market action in any vehicle, be in stocks, metals, grains, etc., is brought about by a combination of fundamental factors, technical factors and market psychology. When a market is at a major turning point after many years in a clearly defined trend, it takes a fairly long time for the changes in the three factors listed above to alter enough to gain the attention of a majority of the market participants. The current situation we are living through is an excellent case in point. We have been in an economic expansion for many years which has produced a long bull stock market. Abby Joseph Cohen, the well-known Goldman Sachs stock market guru has compared the action of the current United States economy to that of a loaded oil supertanker. Such a vessel is hard to get moving due to its great weight and size, but once it does get started it is very hard to stop or to change its direction. Ms. Cohen feels the momentum of our economy is so bullish and so strong that it will be difficult to change its upward march. She recently said she expects the Dow to easily pass 9300 by the end of the year. This is a lady who is so popular and has been so right in her market judgments over the last decade that she can affect the course of the stock market for a day or two with her public statements. With statements of this type from bullish elements, it is no wonder it is hard to change the direction of the stock market from up to either sideways or down.

On the other hand, there are other stock market gurus who feel the fundamentals are not nearly as bullish as Ms. Cohen contends, and that many factors will eventually disrupt the upward march of the United States supertanker stock market. Two such people are Ed Yardeni of the Deutsche Bank and Mr. David Tice of the Prudent Bear Fund. They mention bearish factors such as the Asian financial collapse, economic troubles sweeping through places such as Russia, over capacity in nearly every industry world-wide and dropping commodity prices, which are a big source of foreign currency for developing nations. These problems will leave the U.S. economy surrounded by a world in trouble, with the problems eventually impacting United States markets in a negative way. Both men expect corporate profits to deteriorate, jobs to be lost, and the U.S. to sink into a recession of a magnitude similar to the 1973-74 recession.An especially exacerbating factor will be the disruptions caused by the Year 2000 Computer Date Problem. Another possible very negative factor will be the political and possible economic fall out from the present problems facing our current president. The foregoing negative factors seem enough to worry about, however, without much effort we can find several others. These include trouble between China and Taiwan, India and Pakistan, the Arab States and Israel (some knowledgeable sources feel a war is likely in the Mideast within the next two years), and trouble with the introduction of the new European Monetary Unit.

On the technical side of the stock market there is mounting evidence that we have reached a high point and are due a significant correction. An examination of the traditional Dow Theory suggests we have turned a corner to a bear market. John Murphy, a respected technical analyst, has supplied evidence in his writings that we have enough evidence of a turn in the market to warrant a cautious approach to the stock market. Robert Prechter of the Elliott Wave Theorist has been very bearish for some time. Students of the Elliott Wave Theory will remember that there are many degrees of waves from minor to what is called the Grand Super Cycle Wave (the largest). Prechter feels we are ending a Grand Super Cycle Wave in the Stock Market which started in the 1800's. When you consider the supertanker analogy of Ms. Cohen and the possibility of ending a Grand Super Cycle, it is not difficult to see why it would take a considerable amount of time to change the direction of the market.

It is time to consider the third leg which markets stand or fall on, namely market psychology. It should come as no surprise to anyone that there has been a concerted effort on the part of the investment community and the world's central bankers to downplay the role of gold in financial affairs. Their attitude has been to denigrate, denounce, discard, disown and dislike gold in an effort to keep it in the background of financial affairs, and to keep prices low. You will remember John Maynard Keynes cynically called gold a "barbarous relic". Central bankers and welfare statists have always been opposed to the discipline gold places on their inflationary tendencies, and the higher the price, the more they hate and fear gold. When gold prices are low, the central bankers can promote their fiat paper and digital money with relative ease, and continue increasing paper assets which ultimately grow into a bubble of unmanageable size. My previous articles discuss this in detail.

It has been no easy task for the investment community and central bankers to orchestrate this bearish gold market strategy. Considering the long history of gold in monetary affairs, it is somewhat surprising they have made it happen. In my article A Possible Gold Market Scenario 1998-??, I point out the evidence which suggests gold prices are at a historically low level in 1998, by from $300.00 to as much as $2,000.00.

Now we will pull together the information we have learned, and draw some logical conclusions. From our valuable chart we learned we are at an extreme point in the historical relationship between stock and gold prices, with gold prices being very low and stock prices being very high. A quick review of the fundamental, technical and psychological factors for each of these markets suggest logical reasons for this condition to exist. We have learned that it is reasonable to expect a turning point of this type to require a large amount of time because well established trends which have existed for many years can not be changed quickly. It takes time for the fundamental, technical and psychological changes to become known and take effect.

What can we expect from these markets in the months and years ahead? We can expect the stock market to trend lower. Based on estimates I have read, the level of the DJIA could drop as low as 1000, although the first objective mentioned is in the 5000-6000 range. We can expect gold prices to trend higher. If over a number of years we get back to the lower level on our chart when one or two ounces of gold will buy one unit of the DJIA, then at that point if the stock market is at 2000, for example, then gold would be expected to trade between $1,000.00 and $2,000.00 per ounce. If a scenario exists, where the money supply is expanded to keep the stock prices from falling too low, and the low on the DJIA is only down to say 4000, then we would expect gold prices to range between $2,000.00 and $4,000.00 in that situation.

My previous articles indicate gold prices of that magnitude are not out of the question. In a worst case scenario, if for some reason the Y2K problem turns out to be a worldwide disaster and stock prices should fall to the levels reached in the 1930's of say only 100, then gold could drop to $50.00 to $100.00 per ounce. If such a scenario developed, civilization as we now know it would not exist, and gold and silver coins would still be desirable items to own if we look at the role of gold through history and its ability to bring the owner through perilous times. We should all hope that the last scenario does not happen. Instead, let's hope that at the end of the next downmove on our chart, we start a new upward phase in the history of humankind that will provide many years of happy existence for our children and their children. In the interim period, as the future unfolds, the evidence from this chart suggests to me gold ownership is prudent.

Before we leave the subject of this chart and its messages, we need to discuss some more items. We must remember that this chart is a ratio between two asset classes, gold and stocks, and the price of each asset class used in the calculation of this ratio is denominated in Nominal (current) U.S. Dollars. It says nothing about the absolute value in dollar terms of either component at any given data point. That is why the different price scenarios listed above were included. I would be remiss in my effort to inform with this article, if I did not talk about the absolute value of the dollar, which I will do in the next paragraphs.

There has been much talk in recent months about the strength of the U.S. Dollar, its use as a reserve currency as well as a good vehicle to store wealth. It is vital to keep in mind that when our financial and governmental pundits talk about the strength of the dollar, they are talking in relative terms. All world paper and digital currencies (with the possible exception of the Swiss Franc) are fiat currencies. Fiat simply means the currency has no intrinsic value and the value is based only on the character, reliability, integrity and confidence the users of the currency have in the governmental body issuing the currency. So when we hear the U.S. Dollar is strong, it only means it is in better condition than a basket of other fiat money whose individual components are very weak and sometimes almost worthless. When the purchasing power of the U.S. Dollar is adjusted for inflation and charted over the last hundred years, we find it has lost over 90% of its value or purchasing power in that interval of time. This means if one of your ancestors in 1900 had a wall safe and placed ten one hundred dollar bills in the safe, and the safe was not opened until 1998, that when the safe was opened, the ten one hundred dollar bills would only buy 5 to 10% as many goods as could have been purchased in 1900. When you talk about fiat paper and digital currencies, the U.S. Dollar included, you are looking at a vehicle governments and politicians continually debase which results in a poor store of value and lower purchasing power.

Some recent comments by Judy Sheldon in the Wall Street Journal are pertinent to this point:

High-level officials from the Group of Seven leading industrial countries have been anguishing over what can be done to save Russia from becoming the latest casualty of a global monetary system in utter disarray. They ( the IMF and world governments ) are more inclined to use the value of money as a tool for manipulating financial incentives and human behavior in accordance with the objectives of their prescribed economic reform programs. The world stands to gain from the vital lesson that government control over the value of money involves an inherent conflict of interest. Contrary to protestations about national sovereignty and the need to exercise monetary "flexibility," free markets function properly only when money provides a meaningful unit of account and a reliable source of value.

Moreover, the vast degree of financial integration that characterizes today's quicksilver capital markets makes it impossible to differentiate the domestic value of money from its value in world currency markets over any sustained period. We may be fast approaching the day when the needs of the global economy require a global monetary solution.

Federal Reserve Chairman Alan Greenspan made the observation earlier this year that the 1994 Mexican peso devaluation was the first crisis of the new high-tech global economy. The 1997 meltdown of Southeast Asian currencies initiated the second crisis. Mr. Greenspan predicted with stark candor that there would be a third. Why? Because the fundamental problem of fiat currencies, whose supply is determined by the fallible judgments of central bankers, has not been resolved. It is now clear that the third crisis belongs to Russia.

This section was included so we will not forget the declining real value of the fiat U.S. Dollar, in spite of the constant barrage of news we hear about the strong U.S. Dollar. In addition, we must remember that the world's money system is fragile, volatile, in disarray, and vulnerable to disastrous accidents. In such an environment, gold comes into its own as the vehicle of choice for a store of value. This is very important to remember as we transition through the current turning point in our chart, and look forward to an increasing gold price.

The last point I need to make which we can learn from our valuable chart, is the chart clearly seems to indicate that the "BUY and HOLD PHILOSOPHY" of the Wall Street Community is suspect. They preach the "BUY and HOLD PHILOSOPHY" because they do not have a good timing method which tells them when to switch out of stocks and into another investment area. This little gem of a chart appears to give us a timing mechanism of great value, even though it does not give us the exact day to make the switch. This lack of exact timing is relatively unimportant, since once a new trend is established, it lasts long enough to make taking a position worthwhile.


We have discovered a chart of immense value to investors who want to protect their wealth and to students of the world scene who want to better understand the changes taking place in an unsettled and confusing world. The chart tells us we are in an important turning point in the relative value of stocks and gold, with the next few years favoring owning gold over stocks. If you believe in the value of history, as I do, and if you believe there are cycles in the affairs of humankind, as I do, then this chart provides us with a clear path of action to take for the next few years. I hasten to add, very little if anything is absolutely certain in this unsettled world. So, as in all matters, use caution and common sense.

A REMINDER - If you have found this article helpful, you will benefit by reading my previous articles posted on this website because they are still very timely and have additional insights which are helpful in better understanding my latest article. Just CLICK the hot-wired "Also by JOSEPH M. MILLER" at the bottom of this page.

Minting of gold in the U.S. stopped in 1933, during the Great Depression.

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