The Dow Jones Industrial Average / Gold Ratio: The Mathematical Relationships

This is the fourth post in a series reviewing one hundred years of the Dow Jones Industrial Average (DJIA)/ Gold ratio. The ratio divides the DJIA closing price by the price for one ounce of gold. This ratio presents a striking cyclical pattern over the past century.

This post will focus on the mathematical relationships across three different cycles. In my last post on the ratio, I noted the uptrend of the peaks over the past three cycles. The Roaring 20's peaked around 18, the early 60's at 28, and just prior to the turn of the new millenium, an all time high of 43. From this we conclude that the "highs" keep getting higher. The fact that the cycle increased basically at the same percent (54-55%) between the three peaks is compelling. More interesting, is the fact that all three peaks connect in a straight upward-trending line.

The % gain in the ratio during the expansion phases is impressive. These numbers reveal that the most recent expansion phase was quite significant. The ratio expanded 4097% over 18 years. This represents the most significant increase over the past one hundred years and it occurred during the shortest expansion cycle.

The contraction cycle during the Great Depression "bottomed out" with a ratio of 2.03. The 70's contraction bottomed out at 1.04, a 50% lower value. With only two data points, it's a reach to make any projections, but the trend indicates that the "lows are getting lower".

If the "straight line" trend from the expansion is real and one wanted to "straight line" the contraction bottoms, a projected bottom lands somewhere in the range of 0.5. In 1895, a low of 1.0 was reached. In the first half of the 1800's, the ratio spent a lot of time below 0.5.

The ratio in the first two cycles declined 89-96% from their peaks. On 2/20/09, the ratio at 7.42 represents an 83% decline from the peak of 43.

The contractions in the first two cycles hit a "first bottom" and ultimately fell further to the "ultimate bottom" of the phase. Extrapolating a straight line through the first two "1st bottoms" project a potential upcoming "1st bottom" around 4.7. The ratio on 2/20/09 is 7.42. This "head fake" presents the feeling that the bottom has been found and the upswing has returned. It is likely that in the coming six months, a rally will occur, the media will state "the stimulus is working" and the herd will jump back in only to be hammered at the ultimate bottom.



If the ratio were to bottom in the range of 0.5, that would represent a 99% decline in the ratio from the peak.

The prior posts in this series:

http://randomroving.blogspot.com/2009/02/dow-jones-industrial-average-gold-ratio.html

http://randomroving.blogspot.com/2009/02/dow-jones-industrial-average-gold-ratio_18.html

http://randomroving.blogspot.com/2009/02/dow-jones-industrial-average-gold-ratio_9935.html

PDF's of these charts can be downloaded at:

http://sites.google.com/site/randomroving/Home