Thursday, January 27, 2011
The above chart plots the daily ratio of the S&P 500 index to the spot gold price. Stocks have been doing pretty well in nominal terms, with the S&P now up 92% from its Mar. '09 low. But against gold, stocks are up only 36% from last year's low. The thing that caught my eye is that since the end of last November, stocks are up 10% while gold is down 5%. Gold is down almost 8% (almost $110/oz) since its early December high. Stocks may be on the verge of a significant upswing against gold, after losing 87% of their value from the highs of 2000 through Mar. '09, as shown in the next chart.
Taking a very long-term perspective and ignoring the impact of dividends, stock prices have only just kept pace with gold prices over the past 83 years. This fact lends credence to those who advocate a gold standard, since it shows that gold indeed holds its value against other real assets over long periods, though of course there have been huge swings from time to time. But if the best that gold can do over time is to match the increase in stock prices, while delivering enormous extra volatility along the way, then gold is not a particularly attractive asset from an investment perspective, especially since it pays not a penny of income and in fact costs money to store. And it's particularly unattractive today, unless you are convinced that the Fed is on the verge of committing a major monetary mistake and/or the U.S. is going to default on its debt obligations.
What are the drivers behind this recent development? That's anybody's guess, of course, but here's mine. Borrowing from observations made by my friend Don Luskin, I think the recent rise in stocks and the decline in gold reflect an emerging sense of optimism regarding the economy. The economy is doing better than expected, and it's not just because the Fed is buying Treasuries by the bushel. As I've noted before, it's hard to find evidence that the Fed's QE2 purchases have resulted in any expansion of the money supply; indeed, it looks like they have only managed to keep the monetary base from shrinking. In any event, with the economy doing better, the need for a QE3 definitely declines, and that in turn means less risk of a possible Fed inflation error, plus less risk of some significant, adverse geopolitical or financial crisis. So the case for buying gold at prices that are quite high on both a nominal and real basis is diminished.
Consider also that the long-term trends in stocks vs. gold prices reflect major shifts in the relative attractiveness of financial vs. real assets. That relationship, in turn, is heavily influenced by monetary, fiscal, and political trends. Stocks collapsed against gold in the 1970s, because the U.S. devalued the dollar, the Fed was way too easy, and presidential leadership (Nixon, Ford, Carter) was weak. Stocks then surged against gold from the early 80s to 2000, because the Fed was tight, inflation collapsed, taxes were reduced by an order of magnitude, and presidential leadership was generally good (Reagan, Clinton). Stocks have been crushed since 2001, as the Fed began pursuing a very accommodative monetary policy, government meddling in the housing and financial markets led to a huge housing boom and bust, and presidential leadership has been at best controversial and less than inspiring.
It may not be obvious yet, and I may be jumping the gun, but I think it's worth suggesting that we may be on the cusp of a new era, characterized by improving fiscal policy (e.g., a reduction in the size of government and reduced tax burdens), a return to more prudent and/or rules-based monetary policy, and better presidential leadership. We've already seen financial assets recover a good deal of what they lost in nominal terms in the past three years, but stocks could still gain significantly relative to gold.
Posted by Scott Grannis at 1:05 PM