Dow Gold Ratio Intro
The Dow gold ratio shows the price of the Dow Jones Industrial Average versus the price of gold. It provides important macro information about the relative value between two of the world’s largest markets.
Simply calculated by dividing the price of the Dow by the price of gold, the Dow gold ratio can vary considerably. For example, the 2024 level of 16 remains relatively high compared to the ratio’s 50-year average.
Hungry investors searching for an analytical edge monitor this ratio for a view into how expensive (or inexpensive) the stock market or gold is at any given time. Historically, an accurate analysis enabled investors to prudently favor an allocation to stocks or gold, and profit accordingly.
Important Points
- High readings indicate a potentially overvalued stock market, low readings suggest undervalued.
- Low readings suggest investors should favor stocks over gold, high readings favor gold over stocks.
- In theory, the ratio is unlimited. However, the historical range has oscillated between 2 and 40 with an average of about 10.
- No indicator is perfect. Investors should use other methods of analysis and not rely solely on the Dow gold ratio.
What is the Dow Gold Ratio?
Investors think about the Dow gold ratio in two different ways. Both are correct but frame these markets in slightly differently.
The first way to look at this ratio is a stock market valuation tool. Dividing the Dow Jones by the price of gold removes a measure of inflation from the equation giving a truer picture of the performance of this famous stock index. Through this lens, high values suggest an overvalued stock market and low values suggest an inexpensive stock market.
Alternatively, another way of looking at this important ratio is measuring the relative value of gold versus stocks. This view of the ratio helps the more strategic investor to decide whether to allocate funds into stocks, or, to purchase precious metals instead. Through this lens, high values indicate gold ETFs or gold coins to be a preferable investment and low values indicate stocks to be the better value.
Historical Lessons of the Dow Gold Ratio
Long-Term Chart Observations
– Ratio currently below 1968 peak.
– Never surpassed the 2000 peak (even though nominal prices have).
– Indicates the stock market’s need for inflation, and/or a depreciating USD, and/or stimulus in order to gain in value.
The most sobering data against investing in the stock market is the Dow gold ratio. Over a multi-decade time period it shows the true price performance, a type of inflation-adjusted price. If we’re being honest, as investors, it’s not a pretty picture.
What the ratio makes clear is the driver for growth is inflation. Are we better off than in 1930? In most ways, yes. Has the economy grown since 1970? Of course. However, the true gold-adjusted growth in the Dow ended in 1929. I say that with the caveat that the price of gold was fixed from 1834 until 1971, so it’s impossible to say in the absence of a freely floating gold prices. If you are interested, we’ve written more about gold in the 1970s – it was an incredible time for the asset class.
History of the Dow Jones Industrial Average
Rooted in history and still relevant today, the Dow Jones Industrial Average combines thirty of the largest companies in the U.S. economy. This major index dates back to 1896 and was the second U.S. stock index ever created, after the Dow Jones Transportation Average. It was created by Charles Dow, the co-founder of the Wall Street Journal.
As an investor, I’m always surprised to hear how many people believe this index to be flawed and want it discontinued. Their concern stems from its calculation (price-weighted) and blame it for being unique. Most stock indices calculate component weightings by market capitalization whereas the Dow uses stock price.
“Flawed” or not, the Dow continues to provide an accurate view of the overall stock market and does so with a unique methodology. In my experience, using the same methodologies across the board tends to create blind spots. I’m all in favor of keeping a unique index around as-is. If you don’t like it then use the S&P 500 or any other index.
Components
The Dow is a mega-cap index. Filled with 30 of the largest U.S. companies it gives a tremendous view into the performance of companies favored by U.S. consumers and industry, some of the largest contributors to GDP.
In alphabetical order:
- Amazon.com Inc
- American Express Co
- Amgen Inc.
- Apple Inc.
- Boeing Co.
- Caterpillar Inc.
- Cisco Systems Inc.
- Chevron Corp.
- Goldman Sachs Group Inc.
- Home Depot Inc.
- Honeywell International Inc.
- IBM Corp.
- Intel Corp.
- Johnson & Johnson
- Coca-Cola Co.
- JPMorgan Chase & Co.
- McDonald’s Corp.
- 3m Co.
- Merck & Co. Inc.
- Microsoft Corp.
- Nike Inc.
- Procter & Gamble Co.
- Travelers Companies Inc.
- Unitedhealth Group Inc.
- Salesforce Inc.
- Verizon Communications Inc.
- Visa Inc.
- Walmart Inc.
- Walt Disney Co.
- Dow Inc.
Alternatives to the Dow Gold Ratio
The Dow Copper Ratio
Some alternatives exist if the Dow gold ratio seems like the wrong tool for valuing the stock market. Similar to gold, copper can be a market used to “deflate” the Dow Jones by an inflation proxy. Similar fixed supply means copper has some supply constraints and benefits from inflation due to its high utility value.
Unfortunately, modern finance hasn’t had a means for trading copper for very long and therefore has limited price history. However, it too failed to make a new high compared to 2000 and shows the stock market (as of 2024) to be elevated.
The Dow Crude Oil Ratio
Another alternative to the Dow gold ratio is the Dow oil ratio. Unfortunately, due to several aspects this may not be an ideal ratio to focus on.
For starters, the supply picture continues to change with technological improvements (e.g. fracking) and society’s move toward “green” alternatives. The technological improvements impact the supply side of the market and the non-fossil fuel alternatives impact the demand side. These two act as a headwind to crude oil and will likely make it less of an inflation hedge over a multi-decade time frame.
For this reason, the Dow oil ratio will likely have an upward bias over the long term.
Final Thoughts
Ultimately, the Dow gold ratio proves to be a wonderful tool for evaluating the true performance of the stock market and deciding whether it is cheap or expensive. Investors will likely be rewarded by monitoring this ratio on a regular basis and using it to guide their long-term investing. For investors looking for a sentiment indicator to forecast gold’s monthly or weekly price movements please review our gold Fear and Greed Index.
Gold and the stock market remain two very different markets while both being extremely valuable if you know when to invest in each. This ratio, better than many other methods of analysis, will shine light on the valuation of each. Knowing the value of an asset remains one of the most important aspects of successful investing.
Author
Andrew McCormick, RIA is the Senior Portfolio Manager at Cottonwood Capital Management. Previously, he worked for BlackRock and managed the MKC Global Fund, LP. Andrew’s work has been featured in ZeroHedge, TheStreet, and the Wall Street Journal.