A Market in Search of a Bottom

The Dow Jones Industrial Average is at 6625 as of this writing. The last time the Dow was trading in this range was 1997. Back then it was on it’s way up. The lowest level it ever reached in 1997 was on April 10 when it closed at 6391. If the Dow falls lower than that, then we’re going back 1996.  

Frequent readers of my blog know that I don’t follow the nominal value of the Dow Jones as much as it’s ratio compared to gold. The reason for this is that it the ratio of those two will automatically correct the Dow for inflation without referencing some wonky government statistic that has been worked over by “hedonistic price adjustments” until its lost its usefulness. In terms of the Dow-Gold ratio, the Dow looks far worse because $6625 would go a lot father in 1997 than it would today. The Comex Spot price of gold is in the neighborhood of $930; that would put the ratio of the DJIA to 7.1 ounces of gold. Last time we looked at the Dow-Gold ratio it was a 7.4. Last time it was that low it was the recession of 1991. The ratio is now trading belong its long term average, but it still has plenty of room to fall. People ask me when a good time to look at getting back in to the market is and I say when the Dow is trading at two to three ounces of gold. To paraphrase Dr. Seuss, “When we will get there, I can’t say, but I bet we’ll fall a long, long way.”

The severity of this decline isn’t all that surprising given history, but I don’t think we’re going to find the bottom all in one big plunge. I think we’re going to see a false bottom similar to what we saw in the 1970s. If we take a look at the graph of the Dow-Gold ratio from 1960 through 2000, we can clearly see that the 1970s decline did not happen in a straight line. There were a couple of false bottoms as the Dow rallied only to later fall.

Dow-Gold Ratio Since 1960

The most pronounced of these false bottoms during the 1970s decline was rally from the end of 1974, where the Dow was trading at 3.09 ounces of gold to then rally to 8.25 ounces of gold in 1976. That’s a two year “bear trap” rally that sucked a lot of investors in only to take them much lower over the course of the next four years. Those kind of long, pronounced bear market rallies are the cruelest of all to buy and hold investors. Given that we haven’t really experienced one since the Dow-Gold peaked in 1999, I find it hard to believe we’re going to get off that easy. Particularly with Helicopter Ben at the helm of the Fed.

The upshot of this is that I expect the Dow-Gold to find a bottom this year, and to start to rally. This rally will probably last a good couple of years and will give investors a sigh of relief, but it will ultimately prove to be a false reprieve. Value oriented investors can find some good bargains this year that, if they have the intestinal fortitude to hold it their investments for the long term, they should do quite well. The investors who lack conviction are going to end up getting squeezed out of this market over the next couple of years. Bear markets are where the professional investors really make money and the amateur investors lose it all.

So keep in mind this year that we’re going to see a rise off of a bottom at some point. The mainstream media will jump all over it as the end of this downturn. Don’t buy the hype and certainly don’t buy the rally. This bear market has a lot further to go.

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