One of the important ratios to keep in mind when examining the equity markets is the gold price relative to the major stock market indexes. This provides a valuable insight into the extent to which market values reflect a real shift of sentiment toward equity value, versus the extent to which the value has lost value, driving increases in nominal valuations to simply retain purchasing power. Over the last 35 years, the relative price of Gold1 and the S&P 5002 has oscillated up and down very significantly. In the aftermath of 2008 and the financial crisis, this ratio has regressed toward a value of 1.0, which indicates equal valuation for the S&P 500 index and an ounce of gold. In the latter half of 2010, the S&P 500 vs. Gold ratio dropped below 1.0 as Gold prices were pushed up by speculators seeking to hedge against expected future inflation. Our analysis indicates that this trend is likely to continue through 2011 as monetary expansion inflates both asset classes.
The principal driver of past expansions and contractions of this ratio are changes in consumer sentiment toward business and expectations about price inflation. During the late 1970’s and early 1980’s there was a general souring of investor sentiment toward the prospects for business expansion, combined with high levels of price inflation. This drove the ratio downward quite sharply. As the economic expansion of the 1980’s and 1990’s continued, sentiment shifted toward the stock market as a way to generate wealth. This was reflected in the S&P 500 carrying a valuation over five times the price for an ounce of gold in the late 1990’s.
After the technology bubble burst, and market sentiment for equities eroded, the S&P 500 index began a regression back toward the price for an ounce of gold. This regression has stabilized in the last few quarters as the price of gold pulled even with and eventually surpassed the S&P 500. As 2011 unfolds, we are not expecting to see economic or political conditions that are favorable for business expansion, meaning that price increases for both assets will most likely come from inflation pushing up the nominal values, but resulting in little change for the real value. If the economy slips back into recession from monetary tightening or the cumulative impact of additional government taxes and regulations, we expect to see the S&P 500 price move significantly below the price for gold. Conversely, we anticipate that the S&P 500 will resume a growth trajectory relative to gold when the economic and political conditions become more favorable for expansion. At present, these conditions are not likely to transpire in 2011, and may take until 2012 or longer.
The American Monetary Association Team
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