Wednesday, October 7, 2009

Speculation on the Gold/S&P ratio

Above and below you see a picture of the ratio between gold and the S&P (click for a larger picture.) This is a chart from 2000-present representing the fraction of one S&P index that can be purchased for one ounce of gold. It is a logarithmic chart, and you can see that from the minimum to the maximum, there was an increase of roughly a factor of 8.

To my eye, it looks like gold will likely advance on the S&P once again. It may be that there is a longer correction, or that there will be further consolidation, but it seems very likely that before any sustainable decline in this ratio, there would be one more retest of the maximum.

The ratio had its recent maximum value of 1.366 on March 6, 2009, one day before the low in the S&P. The ratio has backed off quite a bit in the past 6 months, reflecting the fact that the S&P has rallied more strongly than gold. The thing that I would like to point out is that it is very likely that we will see at the very least some sort of retest of the previous high in this ratio. The recent low in this ratio of 0.914 was put in on August 24th. A 50% retrace of the ratio to 1.14 would represent a pretty large shift in either gold or S&P at this point. Assuming the S&P stays put at 1050, this would imply gold would hit $1197. If gold stays put between $1000 and $1040, this would imply a correction of the S&P to between 880 to 910. A retest of the 1.36 ratio would put gold at $1425 or the S&P at 764. Take a good long look at the chart of the ratio again, and I think it is pretty clear that gold will make one more advance on the S&P.

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