Dow, Gold and Your Financial Triangle

A topic of conversation which may hit a water cooler near you is that of the Dow/Gold Ratio and how it affects the growth and income portion of your portfolio.  Around here, we discuss mandates, not assets, and how those purposes and mandates play into the different aspects of a well diversified and organized portfolio.  There are only three things you can do with money; spend it, save it, or try to turn it into more money.  So traditionally there has been a basic understand that for part of your assets are held in cash (spend), part of your assets are held in things that hold long-term preservation in mind like gold or land (save) and the finally, part in the more exciting stuff where there’s the issues of both risk and reward (growth).

Not surprisingly, by means of the traditional human spirit, we take the first and last of those three categories the most seriously.  The first (cash) because it means we get to eat today, and the last (investment) because we want to drink champagne with our steak, not Bud Light with our burgers.  Although those people who focus on the Cinderella of the story, the mandate that encompasses insurance and long-term asset preservation, tend to have the greatest net-worth gains throughout the course of their lifetime, and intergenerationally.  Most of us are not billionaires, but many still hold to the disillusion of grandeur that we may attain that status in a single lifetime.  We think those small handful of brilliant money managers who attain that level of wealth in a single lifetime got “lucky,” and we can get lucky too…

I digress from the point, but only to emphasize the importance of segregating those three mandates from each other and treating each with equal value.  The easy ones are cash and preservative assets.  At all times hold a position in both cash and long-term preservation assets like gold or dirt.  Those mandates never change and the assets that work best for them rarely change either (although every fiat currency inevitably fails, but that is a story for another day).  However, what to do about that pesky growth portion that gets the most interest and attention.  That does not mean that allocating within a certain asset class is proper planning, like buying a lot of different equities in different industries, but that is what the average Wall Street mogul needs to sell you, because it’s an easy way to package and liquidate off the shares of certain items their firm wants to get rid of.  Instead, consider allocating your growth portion among different asset classes that serve different purposes at different times of your life.

What the heck do I mean?  Since I disagree that holding a broad-based stock portfolio long enough will just naturally cause gains, I recommend viewing that benefits of different industries depending on important factors like Dow Theory, unemployment and inflation/deflation figures, and of course, the Dow to Gold Ratio.  Sure, the US Stock Market has made marginal corrections off of the tragedy that befell 401k and pension plans nationwide back in 2008/2009, but where’s the growth?  The rule of 72 helps us ball-park the frequency of a doubling effect on our investments, but it’s been 10 years and most people are only up the money they’ve put in.  All the while, our cost of living has more than doubled. Why not, instead of becoming addicted to any particular growth asset, you consider buying the right growth asset at the right time.  And most importantly, having a reasonable exit strategy.

The unfortunate reality is that this only works because not everyone does it.  We know what happens when everyone plays the game at the same time, the game gives up on them.  For examples, look at the “(insert financial term here)” – bubble.

And now here’s the topic at hand, the great and magical Dow/Gold Ratio and how it has played out over the last hundred years or so.

Dow to Gold RatioWhen all that is said and done, how does it apply practically?  Look at the spreadsheet below.  Assuming an initial investment of $30,000.00 in precious metals in the year 2000 at a rounded $300.00 per ounce.  Or, 100 ounces of exposure to the gold market.

Gold vs GEAt that time you could have purchased 100 ounces of gold or 500 shares of General Electric Stock.  I use GE because they are the original big boy and only remaining one on the DJIA today.  The Dow/Gold Ratio was at 40:1 at the time.  Today, we are roughly 8:1.  By swapping that gold out you could now pick up over 8,000 shares of GE, and at roughly 0.48 cents per share annual dividend, you’re now picking up $4,000.00 a year. But look how things compound from here if we move to a 3:1, 2:1, and maybe even a 1:1 ratio between gold and the DJIA.  A swap out of gold into GE at today’s dividend yield, and in 10 short years you have leveraged your purchasing power into GE 116 fold, and are earning annually in dividends almost what your initial investment was, 58,100 shares netting $27,888 a year.

For more information, please click on the LINK at the top right of this blog, The McAlvany Weekly Recap and read the article for Sept. 17th, 2010.


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