Tuesday, 3 June 2008

Megaphone top in Dow:Gold ratio? 2008-06-03

Tuesday 3rd June 2008: Megaphone Top in Dow:Gold ratio?

In this entry I am going to repeat a lot of the previous entry because I wanted to draw attention to the pattern of the Dow:Gold ratio again. Today, I have just found a fascinating entry on the internet on the Trade Talk Weekly website, concerning the Megaphone Top Chart Pattern.

Look at that pattern and see if it is not almost exactly the same as the pattern of the Dow:Gold ratio in the last 70 years, then read the rest of my entry, especially point 3 near the end, repeated from the last blog article. The above website would suggest a breakdown at the next visit of Dow Gold to the 1:1 ratio, which might imply a long period of decades to follow with a ratio of less than 1:1!

Not every mention on the internet of the megaphone chart pattern correlates exactly with this but in any case I shall draw it here:

We have entered into a period, shown by the increasing and extreme amplitude of oscillation of the Dow Jones stock index to Gold ratio, where it is becoming impossible to value anything in terms of money, or even in terms of anything else. The entire economic system is completely broken. Many say that the Dow:Gold ratio measures values of paper assets vs real assets. I think that it is only part of the story. In fact, the Dow stocks represent real companies and real productivity and are therefore semi-tangible. Although the stock prices are based on 'faith' or confidence in those companies and are paper assets, their values are also governed by sales, profits, cash dividend payments and other 'real' assets of those companies such as real estate, plant and equipment.

The wild oscillation of the Dow:Gold ratio from 1:1 in 1980 to 43:1 in 2000 is a change by a factor of above 40! This means that, in a fiat money system, the value of one asset is not knowable in terms of another asset within a factor of 40! This is outrageous in a so-called 'stable' economy and is proof positive that the economy is not stable. I think that this huge volatility is a key factor that has been ignored.

Note from my previous blog entries (Chart hints at Financial Disintegration: 2007-12-23) that the instability began in the 1920s, shortly before the USA went off the Gold Standard, but after World War I when many industrial nations had already left the Gold Standard (such as England in 1914). Coincidence? I think not!

Contemporary with this was the Hyperinflation in Germany of 1923 and a short re-emergence of the Gold Standard in England in 1925, unsustainable because of highly inflationary policies during that period. The 1920s stock market bubble is what led to the first major off-trend high on the chart - and the major low that followed is the early 1930s 90% crash in the Dow Jones, which was followed by the seizure of private gold by Roosevelt in 1933 and the subsequent 40% US Dollar devaluation from $20.67 per ounce of gold to $35 per ounce.

The above chart is my adaptation of the Dow-Gold since 1800 sharelynx chart, with thanks to Nick at sharelynx for permission. The full sized edited chart with trendlines was here, until AOL closed down their webpage hosting in early 2009!

The bottoms of the Dow:Gold ratio in 1933 and 1980 represent major recessions/depressions, one deflationary and one inflationary. The ratio is oblivious to which. The three tops in 1929, 1966 and 2000 represent the euphoria of stock market/financial manias, regardless of the level of inflation at the time, although they probably all represent inflation (in paper aassets, though not necessarily in consumer prices).

In fact at the time of highest consumer price inflation during the 1970s, the Dow:Gold ratio was falling fast. The previous fall in the 1930s was during a deflation (with the 1933-34 inflationary policy of dollar devaluation accompanying it)! In both cases, stocks fell massively with respect to gold.

The present fall since 2000 has now gone further than this chart shows, to a ratio of 12 (12,000 Dow and $1000 Gold) and hints at serious recession/depression to come. However, it says nothing about whether it is inflationary or deflationary. It merely shows the destruction of financial assets by one form of default or another. Deflation is default through non-payment and bankruptcy; inflation is default through devaluation of the currency and consequent loss of purchasing power of the nominally repaid debt.

I hinted that this may render the inflation/deflation debate somewhat meaningless and these were possible conclusions from the chart pattern:

1. In both cases ('30s and '70s, deflation and inflation), stocks fell massively with respect to gold.
2. The economic instability is increasing with every cycle and valuing anything correctly is becoming impossible, which hints at economic and monetary destruction, possibly at the next extreme of the cycle.
3. This chart pattern is like a positive feedback loop as I described in an earier blog entry. Unlike other chart patterns with trendlines, it is impossible to break out of these expanding trendlines, unless a catastrophic event occurs on the downside or upside. The only option would be to try to stabilise the ratio within these trendlines, near to the mean. The swing is already a factor of x43, so do you think it will be possible to stabilise within these trendlines near to mean, to get the ratio to sit in the original green channel again, under this present monetary system? I don't.
4. With each oscillation, the Dow:Gold ratio is spending less time above the original, stable, slowly rising green trend channel and more time below it. This hints that financial assets in a secular sense are becoming gradually less favoured than tangible assets (gold). It hints at a shift away from trust in fiat money. It might hint subtly that industry and investment in the future might not not be able to function under fiat money.

Now let's look at the Megaphone Top formation again with potential dates added:

So, what's the measured move then? See next posting.

Text Copyright 2008. D. Bellamy.

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