Dow:Gold ratio makes $12,400-an-ounce gold look a realistic target

It was fascinating to read the comments of ‘Mr Gold’ Jim Sinclair this week about gold heading for $3,500 to $12,400-an-ounce as a result of a shift in spread management by the bullion banks. He used to run one so knows exactly when and why these banks are likely to slash their short positions and go fully long in the precious metal.

However, a consideration of the famous Dow:Gold ratio is also relevant here as a confirmation of where this price swing will go. Historically the ratio of the Dow Jones Index to the price of gold has in extremes swung to parity with one ounce of gold equal in value to the dollar-value of this index (see graph below, it is an unmistakeable trend).

1980 Dow:Gold ratio

In 1980, for example, $850 an ounce gold approximately matched 850 on the Dow Jones Index. With the Dow around 13,000 today it would require a gold price of $13,000 to deliver the same Dow:Gold ratio of one.

Of course if the USA moved into a deep recession in 2013-14 then you might anticipate a Dow Jones Index some 30-50 per cent lower. In that case gold prices would only have to move to $6,200-$8,680 to achieve the magic parity in the Gold:Dow ratio.

Mr. Sinclair’s lowest estimate for the top gold price of $3,500 an ounce would have the Dow plunging by 75 per cent in a massive sell-off. Therefore, those who are optimistic about the ability of Fed to support high stock market prices by printing money also ought to be very confident about a massive hike in the gold price.

The next issue of the ArabianMoney investment newsletter will return to the theme of precious metals and how to extract the maximum investment upside from this historic price shift and the sort of additional risks that you have to take to achieve this. (subscribe here).

Physical metal

Mr Gold himself always advises a core position of physical metals held in a secure location. Both gold shares and playing with derivatives have additional risk but arguably superior rewards for the expert or fleet of foot. The ArabianMoney investment newsletter has a simpler approach to achieving the same thing, though we concur with the idea of the junior gold companies as likely to deliver the highest total return in the long-run.

But as the Dow:Gold equation suggests it is far more likely that gold will outperform shares than vice-versa. Still if the Dow headed up to 17,000 then the Dow:Gold ratio would imply $17,000-an-ounce gold, although we note Mr. Sinclair does not even consider this possibility.