The recent market uncertainty is no doubt causing investors some angst. That’s especially true for those in or nearing retirement. The ‘professionals’ keep reassuring us the global economy is slowly recovering and that this will underpin future market performance.
But this ignores the fact that the economy and markets have the twin props of money printing (QE) and zero interest rate policies (ZIRP) supporting this so-called ‘recovery’.
So when or if central banks remove these props what are the consequences?
The unprecedented levels of central banker intervention are a result of The Great Credit Contraction (GCC). The GCC isn’t your ‘run of the mill’ recession. It’s a result of the collapse of a credit bubble the likes of which the world has never seen before.
And so a genuine recovery can only take place after slowly and painfully removing the massive build-up of debt from the system.
Therefore, it’s dangerous to have an investment strategy that presumes the worst is over and that you’ll shortly see a return to ‘normal service’.
My guess is those who believe in the ‘share market always goes up’ mantra will run out of money and patience long before this market delivers on that Secular Bull Market promise.
Central Banks Can’t Deny This Major Trend
Recent data from Europe and the US show these economies are, at best, limping along. The inclusion of vast amounts of stimulus money has inflated the anemic growth numbers. Take out the government giveaways and you’ll see their real economies are well and truly in reverse gear.
That means in this new world of credit contraction, an investment strategy based on how things worked in recent decades is destined to make you much poorer. And as this loss of wealth effect slowly embeds in society’s psyche, you can expect to see more direct intervention by policy makers.
Forget taper, they’ll continue to tamper.
The central bankers are trying (in vain) to alter the market’s destiny with economic reality. Based on previous interventions, any success will be fleeting. The fact is markets respond to the stimulus steroid until they don’t. But for the central bankers, withdrawal isn’t an option so the market will likely ‘die’ from a stimulus overdose.
Having a big picture strategy and a good deal of patience lets you view these market movements as part of the longer-term trend. It’s a trend in which the market goes much lower.
Holding cash while markets fall is the first half of the strategy. The other part is deciding when to begin investing in markets again. One of the indicators to watch is the Dow/Gold ratio.
History has shown that gold is ‘the ultimate store of wealth’.
In the good times investors chase markets (paper money) and in the bad times they go back to gold (real money). The Dow/Gold ratio tracks this ‘greed and fear’ relationship.
The following chart of the Dow/Gold ratio shows how investors fall in and out of love with each asset class:
Note: Prior to 1896 a surrogate index is used for the DJIA Index.
Source: www.bullmarketthinking.com
It’s interesting to note the level of volatility before and after the creation of the US Federal Reserve. After the Panic of 1907, the creation of the US Fed was supposed to be the great stabiliser – at least according to the Act. The following is an extract from www.investopedia.com :
Definition of ’1913 Federal Reserve Act’
The 1913 U.S. legislation that created the current Federal Reserve System. The Federal Reserve Act intended to establish a form of economic stability through the introduction of the Central Bank, which would be in charge of monetary policy, into the United States. The Federal Reserve Act is perhaps one of the most influential laws concerning the U.S. financial system.
The graph confirms what we already know – that when authorities and bankers meddle, the markets go haywire. Bernanke and co are continuing a long tradition of central bankers who think they are smarter than the collective.
(The fact we don’t need central bankers at all is a discussion for another day.)
But let’s go back to focusing on what history may tell us about the near term destiny of these two asset classes.
Your Best Bet May Be to Take a View From Here
At the peak of the ‘tech boom’ in 2000, the Dow Jones Index was 11,700 points and the gold price was at a low of $280 per ounce. That means the ratio was 42 (11,700/280). In a two-century period, the 2000 Dow/Gold ratio peak has been the pinnacle of greed and over-optimism.
The Dow Jones index is currently around 14,900 points and gold is $1,365 per ounce, giving a ratio of 10.9. Previous secular bear markets show the Dow/Gold ratio reaches a low of 1 to 2 before a market collapse is complete (the depth of fear and pessimism).
How do we get to a ratio of 1 or 2? There are four main equations (and a number of variations on them):
- The Dow stays around current levels and gold rises to $7500/oz or higher – these were the dynamics that caused the Dow/Gold ratio to bottom out in 1980.
- Gold stays around currently levels and the Dow falls to 2700 points or lower – these were the dynamics that caused the low in the Dow/Gold ratio during The Great Depression.
- The Dow falls in value (say to 7000 points) and gold increases to $3500/oz or higher.
- Both gold and the Dow fall to much lower levels – say gold at $500/oz and the Dow at 1000 points – this is the deflationary scenario The Great Credit Contraction may deliver to us.
The previous lows in the Dow/Gold ratio have come about by differing dynamics. This tends to add credence to the saying, ‘History does not always repeat itself, but it does rhyme.’
If the long-term cycle of a lower Dow/Gold is in our future, it’s unlikely the Dow will increase from current levels. Best case is the Dow remains stagnant. The higher probability is that it falls – possibly 50% or more.
A fall of this size is also reflective of the pattern of past Secular BearMarkets. There are times to be brave and times to be cautious. For me caution is the better option.
In short, my position is to remain on the sidelines in cash and be an interested spectator.
Vern Gowdie+
Editor, Gowdie Family Wealth
From the Archives…
How Many Warren Buffett’s in a Bar of Gold?
16-08-2013 – Kris Sayce
Two Points to Consider from the Commonwealth Bank…
15-08-2013 – Kris Sayce
Take Control of Your Superannuation, but Know the Limits
14-08-2013 – Vern Gowdie
Why I’m Glad I Missed a Dividend Stock That Doubled…
13-08-2013 – Kris Sayce
No Profit in the Federal Reserve Divination
12-08-2013 – Dan Denning
