Wednesday, April 17, 2013

Stocks surge relative to gold

In a previous post on the subject of gold re-linking to commodities, I mentioned in passing something that Larry Kudlow reminded me of recently: the last time gold suffered such a huge drop (January 1980) was 2 1/2 years before the economic and stock market boom of the 1980s got underway. Lots of things are different this time around, of course, but it's an idea worth fleshing out.

The first chart above shows the ratio of monthly spot gold prices to the S&P 500 (just the index, not including reinvested dividends) over the past 85 years, while the second chart shows the ratio of daily prices over the past five years. As should be obvious, we have just seen a significant change in the relative strength of stocks and gold. Stocks appear to be on the cusp of a new trend, rising in terms of gold, and this could portend optimistic tidings.

Over the time period of the first chart, there have been only two episodes in which stocks strongly outperformed gold over a sustained period: the first, from around 1950 to around 1965, and the second, from late 1982 through 2000. In the first period, real GDP grew at an annualized rate of 4.5%, which is substantially more than the the 3.1% long-term average growth rate of the U.S. economy. In the second period, real GDP grew at an annualized rate of 3.7%, well above average. Real GDP growth was below average in the periods during which stocks fell relative to gold, the worst being from 2000 through 2012, when real GDP growth was an annualized 1.6%.

Of course, changes in the ratio of stocks to gold aren't what drives economic growth. Rather, it is strong economic growth that drives stocks higher relative to gold. During periods of healthy growth investors naturally gravitate to equities at the expense of gold, because profits are rising, stocks pay dividends, and gold yields nothing. When growth is weak, uncertainties typically abound, profits are squeezed, and gold gets the nod in favor of equities because speculation tends to supplant investment.

The upturn in stocks is thus a preliminary indicator that the economic fundamentals may be shifting in favor of equities, and that, in turn, would suggest that the long-term outlook for the economy is improving. Probably not immediately, but some time in the next few years we could see some genuine improvement in the economic fundamentals. Markets are always forward looking, and this indicator (the ratio of stocks to gold) could be one of the most forward-looking of all. Let's hope so.


The Commodity Guy said...

You are probably using cash prices. If you looked at total return, it would look much worse for gold. Here's a blog that does some long run valuation on gold. Looks bad for a long time.

Gloeschi said...

What is Larry Kudlow saying about AAPL now? It's become rather quiet in this regard on this blog.

d from wi said...

Hi Scott,
I've been a long time reader and appreciate your thoughts and work. What do you think copper is telling us if anything now?

Scott Grannis said...

Re: copper. It looks like all commodities are being dragged down by gold, so I don't know if copper has any special message. I note that copper is still up 425% compared to its late-2001 low, so it's not obvious that copper's recent decline is predicting any kind of disaster for the economy, or reflecting any significant economic weakness. Copper has been relatively flat, with the exception of the big plunge that all commodities suffered in 2008, since 2006. It's actually rather impressive that it has been so strong for so long.

Benjamin Cole said...

Remember, investors and citizens: All gold is fool's gold.

Scott: You indicate the the index does not include returns from dividends. That is huge no?

Over the decades, dividends really add up...making gold an even more dubious investment.....

wesley mouch said...

Benjamin is an irrational gold hater. You are a nutter.
Gold is merely a currency like USD, Swiss francs etc. There have been time periods where stocks have outperfomred bonds for very long periods and periods where bonds have outperformed stocks. Most of us choose to own both at all times since we cannot guess correctly consistently. Similarly there are periods when holding gold have been highly profitable and have helped smooth out returns. The 1970's is the most recent example plus the period of 200 to today. Because we choose to hold some gold as a counterbalance to the rest of our portfolio does not mean we deserve derision from the irrational gold haters such as yourself. Maybe you should get an education before posting