Deflation? Only for the Stock Market

I have to take a moment to pat myself on the back.

Around the start of the new year, I said that deflation was not going to be the main concern, and instead, it would be inflation that was going to be making a comeback. As it turns out, the January numbers are in and CPI inflation is up, not down .  Gold closed at $993 an ounce today and is poised to soon break into new all-time highs. In this way, gold is serving its traditional purpose — as the canary in the coal mine warning all of us that things are not well and that danger, (in this case, inflation) is on the way.

Not everything is going up, however. Yesterday, the Dow Jones closed at a 6-year low. Today it went down even more — so now it’s flirting with its 10-year low. The Dow-Gold ratio, which I’ve talked about before, is rapidly reaching new lows. Dividing the Dow’s close of 7365 by gold’s close of $993 gives us a Dow-Gold ratio of 7.4, which is the lowest it’s been in roughly 20 years.

But it’s going to keep heading down even further than that. Soon, we should be seeing a Dow-Gold ratio of three or even two …

Imagine the Dow at 5000 and gold at $2500 an ounce and you get an idea of what the future holds. Continue reading Deflation? Only for the Stock Market

The Dow-Gold Ratio Renders Its Verdict

As those of you who have read my book know, I’m a firm believer in the power of looking at the daily closes of the Dow Jones Industrial Average and comparing it to the price of an ounce of gold. For those of you who don’t know, the Dow Jones started as a simple average of the share price of all of the companies that comprise it; for example, if there were three companies on the comprised the Dow average that had share prices of $5, $10, and $15, then the average would simply be $10.

Over the years, the number of Dow companies that comprise the Dow has risen from the original twelve to now include thirty different industrial companies. Since it’s simply an average of the number of companies, expanding the number didn’t have much impact. it’d be similar to looking at the average test score for classes of different sizes: more or fewer students don’t matter as we’re looking at an average. The reason the Dow Jones Industrial Average (DJIA) is such a large number in comparison to the stocks that comprise it is that those stocks have had numerous splits throughout the years while the Dow has not. Rather the Dow simply corrects for splits so as to maintain a continuous average throughout time. Just as the price of a single share of Microsoft stock would be $8928 at the close of 2007 if it had never split, the DJIA is a average of companies with such share prices. Continue reading The Dow-Gold Ratio Renders Its Verdict

Seven Days of Loses Makes One Weak

Ouch! The poor Dow Jones Industrial Average has continued it’s rout for the last 7 days. Falling from 10750 to close today at 8579. That’s a decline of roughly 20% in one week. If we go back one full year, the Dow closed at 14164 on 10/9/07. A loss of roughly 40%. Put those two numbers together and we see that the Dow has suffered half of its 40% decline on the year in the past seven trading days.

Gold closed the day at $910. For those of you who have read my book and are interested in the Dow-Gold ratio, gold was priced at $730 an ounce one year ago. It’s $910 today. So the Dow-Gold ratio has fallen from a ratio of requiring 19.4 ounces of gold to buy 1 “share” of the Dow a year ago to only requiring 9.43 today. That’s a decline of roughly 51% in one year. Any way you slice it, stocks have been an absolute bloodbath.

It’s been a good market for us bears, and it will continue to be. I am predicting that the Dow-Gold ratio will continue to fall all the way to a bottom of two or three. That’s another 70%+ loss or so, but I don’t think it will come this year. I think the stock market is do for a snap back. The carnage will take a breather and it will lull in people who feel it’s a good time to buy. People who do so hoping to make a good long term investment are going to be sorely disappointed. You might see some short term gains, but it’s still a long way down. It’s a traders market.

I haven’t seen many stories today discussing these market declines in terms of the Efficient Market Hypothesis (EMH). In years past, whenever you’d see these market declines a Hedge Fund somewhere would suffer some huge loss. Typically the press would ask the manager for a comment and the manager would say something like, “The market activities of the last couple of weeks of market activity are so extraordinary that they were impossible to predict. These types of market only occur once every 1000 years.”

Those statements were based on predicting stock market returns as a normal distribution about a daily average with each day having no influence on the days following it. As we’re seeing, that’s just not the case. The last few days along have seen a string of huge loss after huge loss one right after the other. That’s not bad luck; that’s a bear market.

I have a hairstylist friend who works in a very expensive hair salon. She keeps my book at her station and has noticed a lot of people asking about it lately. It prompted one of her clients revealing that she and her husband had lost the entire $250,000 investment they had made in a hedge fund just a few months prior. Which just goes to show that old story about a fool and his/her money.

Short term corporate bonds are going for unheard of yields.  The search on my Scottrade account is showing annualized yields of 80.9% for National City Corp bonds maturing in April of next year, and that’s but one example. There are plenty others. Those National City Corp bonds have an A3/A- rating, but it seems no one is trusting the rating agencies anymore. And why should they. Washington Mutual bonds were rated as investment grade until just a couple of weeks before they became worthless. With events happening like that, April of next year can seem a long time away indeed. But it does represent a good opportunity for the Michael Millken’s of the world who can sift through the financial statements and sort out the goods bonds from the bad. Then again, with all the accounting shenanigans and off balance sheet Structured Investment Vehicles, who can really tell the junk from the gold anymore. 

That’s the problem with markets that aren’t transparent. No one knows what’s good, so they abandon everything. Until we start to see the yields on these bonds coming down, credit markets will continue to be frozen. That means capital is at a premium and stocks are going to have real trouble doing well. What the next market development is is anybody’s guess.