Gold, The Dow, Bubbles And The Coming Correction

by: Jason Hamlin


The Dow Jones Industrial Average is trading at all-time highs. The Nasdaq and the S&P 500 are similar. This begs many questions.
  • Are the high stock prices supported by fundamentals or have they been levitated with "easy money"?
  • Bubbles always collapse and prices crash. Stock indices are too high, but are they in historical bubble territory?
  • What about gold, silver, real estate and bonds? Are they also in bubbles?
 
Quick Conclusions: Easy money and massive debts, thanks to the Federal Reserve and fractional reserve banking, have created overvaluations and bubble like prices in stocks, bonds and real estate. Gold and silver prices have suffered. Expect reversals!
 
Why?
 
Consider a century of the DJIA (Dow Jones Industrial Average) on a log scale. The index has exponentially increased. But during the past century, the purchasing power of the U.S. dollar has declined 97% to 99%, which accounts for much of the increase in the DJIA.
 
 
The Nasdaq is similar. National debt increases, commercial and central banks pump dollars into the economy, the excess dollars devalue all existing dollars, and prices rise. Further, many of the created dollars since 2008 have been invested into the stock and bond markets, propelling them higher. Rising debt and minimal interest rates encourage real estate speculation, stock buybacks, bond rallies, margin loans and unsustainable prices. Mortgage debt, corporate debt, margin debt and consumer debt have again reached excessive levels.
 
National Debt
 
Debt has increased at roughly 9% per year for a century.
 
 
Thought experiment: Which presidents, congresspersons, lobbyists, Deep State supporters, military contractors and entitlement recipients want spending and debt reduced?
 
Spending and debt will increase until they can't, which might be years into the future. Expect more spending and debt increases, which will further devalue the dollar and cause price rises in stocks, bonds, commodities, medical care, consumer goods, college tuition, gold, silver and more. Some will rapidly increase while others languish.
 
 
"Easy money" has been a large contributor to higher prices. Yes, technology, productivity and genius have been important in some cases, but central banks desire and instigate continual devaluation of their currencies. Higher prices for stocks and bond result from "printing money."
 
 
Bubbles?
 
Bubbles occur when prices spike higher independent of fundamentals and relationships to other prices. Look at the rate of change indicator (ROC) for the Nasdaq 100 Index. This indicator calculates a comparison of prices versus 12 months previously. It is one of many "bubble" indicators.
 
 
 
The maximum ROC for the Nasdaq 2000 bubble was 121. Current ROC is 33. The Nasdaq ROC is historically low compared to the bubble of 2000, as the current rise in stock valuations has been more gradual.

The maximum ROC for silver in the 1980 bubble was 468. The maximum ROC for silver in 2011 was 161, far below the bubble territory of 1980. Silver and gold are clearly not in bubble territory in June 2017 but look very undervalued historically.
 
 
What About Gold Compared to the DJIA?
 
Both gold and the Dow have risen exponentially for many decades, as the dollar has been devalued.
 
The ratio of gold to the DOW shows the relative strength of both.
 
Gold prices are relatively low compared to the DJIA, based on a century of data. The ratio is currently about 0.06. The next gold spike upward could easily push the ratio 5-10 times higher, mostly due to higher gold prices and partially due to a Dow correction.
 
 
More Evidence That Gold and Commodities Are "Too Low" Compared to Stocks
 
Since 1971, according to the above graph, the GSCI (Goldman Sachs Commodity Index) ratio to the S&P 500 Index has averaged about 4.1. It currently stands at about 1, similar to levels at gold lows in 1971 and 1999.
 
 
 
This ratio suggests that the next crisis - war, financial, credit, derivatives, whatever - could elevate the ratio from 1 to 5 or perhaps 10. A few possible crises come to mind: Canadian housing, Italian banks, U.S. debt ceiling, war with North Korea, war with Iran, Chinese credit collapse, U.S. economic downturn, gold delivery failure, China announces the truth about their gold holdings, and many more.

Prices can fall without an external stimulus. They can rise too high and be unsustainable. Prices on the Nasdaq, DOW and S&P, in spite of High Frequency Trading and central bank levitation efforts, may fall for no particular reason or for many reasons.
 
From the brilliant John P. Hussman, Ph.D., in his latest commentary, "Three Factors":

"... the market is in the process of tracing out the blowoff finale of the third speculative financial bubble since 2000."
"... our outlook does remain hard-negative..."
"... I continue to have every expectation for a 50-60% loss in the S&P 500 over the completion of the current market cycle."
Conclusions
  • Stocks and debt have increased significantly for over a century. Expect the debt increases to continue... until they can't, whenever that will occur.
  • "Easy money" has levitated stocks, bonds and real estate to near-bubble levels. Global central banks have shoveled currency into the markets, and several have aggressively purchased stocks (Japanese and Swiss central banks, U.S. PPT?) to support stock markets. We do not believe these practices are sustainable over the long run.
  • Rate of Change (12 months) indicators have exceeded 100 in historical bubbles, such as 1980 silver, 2000 Nasdaq and 2007 Shanghai. Based on the ROC indicator, neither the Nasdaq, S&P 500, DJIA, gold nor silver are currently in historical bubbles.
  • Stocks may not be in historically valued bubbles when looking at the ROC, but they are too high by dozens of measures, including P/E ratio and margin levels. Gold and silver are priced low by comparison with the above stock indices. Expect reversals and much higher gold and silver prices.
  • Do your own due diligence, but in my opinion, gold and silver and shares in the companies that mine them should rally strongly over the next several years, and most stocks should correct from their lofty prices.

  • A major crisis, of which many are possible, will accelerate stock market declines (not including gold and silver stocks), gold and silver rallies and central bank intervention to "support" the stock markets. Central bank "money printing" and resulting inflation will create other disasters.
  • Are you prepared?

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