Sunday, May 8, 2011

Industrial Metals to Gold Ratio - A Warning?

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I like ratio charts to give a sense of relative value. This is important to me because we live in an anchorless fiat world where price is not meaningful in a vacuum. Gold is the global monetary anchor, whether paperbugs care to understand/believe it or not. I have always liked the copper to Gold ratio but other industrial metals in their ratio to Gold can give similar information. I find the current chart of the $GYX (an industrial metals index) when priced in Gold (i.e. a $GYX:$GOLD ratio chart) rather interesting.

Here is a log scale ratio price chart of $GYX:$GOLD since 2003:

The last major trend line break was a warning signal for the end of the last cyclical general equity bull market. Will history repeat? I believe it will but I have no interest in shorting the stock market at this time. I may after a confirmed major trend line break in general equity indices and a subsequent relief rally higher, but not now.

Pricing things in Gold is an important concept for those who hold physical metal. It is shocking to see how much the Dow Jones and housing prices have declined in Gold terms since their peak. The nominal declines are much less severe. This is why printing is the best way out for governments around the world. It worked in the 1970s and it might just work again. The problem for the U.S. is that its problems are much bigger this time around than in the 1970s, so that the amount of monetary inflation needed to combat the ongoing economic problems is much greater.

If the Dow Jones Industrial Average is at the 10,000 level in 10 years but a loaf of bread costs $15 at that time, many people will be fooled into thinking things aren't that bad. The boiling frog analogy is apropos here. Private debt is being extinguished by putting it on the public books! This is high treason right in front of our eyes, but it will continue. Consider Fannie Mae and Freddie Mac needing $259 billion from taxpayers to bail them out. Now this $259 billion is a current number and it will go higher before the real estate bust is over - count on it since the government now backs 85% or so of all mortgages in the United States.

When you transfer all that bad debt to the government balance sheet, you weaken the currency. U.S. Dollar-centric deflationists assume that the laws will be followed and that what is reasonable and appropriate will be at least a minor consideration. These assumptions are erroneous, as recent policy decisions and policymaker law breaking have shown. What if almost all the bad debt created and/or held by "the friends of Angelo" [i.e. Angelo Mozillo of Countrywide], by which I mean to sarcastically refer to the major financial corporations of America, is placed on the government balance sheet?

Gold is a buy at current levels. The current monetary system will be replaced before this secular equities bear market is over, whether in 5 years or 15. The best way for the average person to protect their financial wealth is to buy and hold physical Gold outside the banking system. Other precious metals should also do well and may do even better, but they carry a higher risk. The longer the chaotic policy response to unavoidable economic outcomes continues, the higher the chance that the Dow to Gold ratio will fall below 1 this cycle and the higher the likelihood that this ratio will bottom with Gold in 5 digit territory.

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