Saturday, February 26, 2011

Chart of the Week: Dow-Gold Ratio

The Dow-Gold ratio chart suggests valuation extremes lie ahead.

Knowledgeable correspondent Brendan O. recently sent me this long-term chart of the Dow-Gold ratio. I have reduced the chart a bit and marked it up with what I see: a stupendous megaphone (pennant) pattern, which if extended targets a Dow-Gold ratio of less than one.

The ratio is simple: divide the Dow by the price of gold per ounce: 12,130 divided by $1,409 = 8.6.

This is already already outside the channel--not surprising, as gold has quadrupled from its lows around $300, and tripled from the $400 level of just a few short years ago.

This chart suggests two possibilities to me:

1. The ratio could spike back up into the channel, meaning gold could briefly fall in price and/or the Dow could briefly rise. Just such a retrace spike occurred in 1970s.

2. If the megaphone pattern extension plays out, then either gold must rise significantly from current levels, or the Dow must lose much of its value, or some combination of the two.

The Dow could fall to 2,000 while gold rises to $2,200/ounce, for example.

Nobody knows if that extension will pan out, or what will happen with either gold or stocks, but this chart suggests the ultimate extremes may well be ahead.

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