What the Dow-to-Gold ratio signals for the market

The Dow-to-Gold ratio serves as a crucial indicator for understanding the dynamics between the stock market and precious metals. By comparing the performance of the  Dow Jones Industrial Average with gold, this ratio offers valuable insights into broader market trends, potential economic shifts, and investor sentiment. 

 By analysing historical ratios dating back to 1897, Patrick Karim of NorthStart & BadCharts ratio reveals recurring cycles, where significant transitions in the market often follow a breakdown in the Dow’s performance relative to gold. This breakdown signals a capital rotation event, where investments shift from equities to commodities such as gold, silver, and oil – assets that are traditionally viewed as safer during periods of stock market underperformance.

Historically, when the ratio breaks down and gold begins to outperform the Dow, it signals a change in the market, often marked by a shift of capital away from equities and into safer, tangible assets like gold, silver, and oil.

These cycles often precede significant recessions, creating an environment ripe for a capital rotation event. This process identifies when capital flows out of speculative assets like stocks and into tangible hard assets. With the Dow showing signs of weakness compared to gold, the probability of further downturns in the broader market increases. As Patrick points out, the Dow-to-Gold ratio has often acted as a leading indicator, with the S&P 500 and NASDAQ following suit.

Capital rotation explained

Capital rotation refers to the process of moving investments out of riskier assets, such as growth stocks, and into more stable, hard assets. This often occurs when the stock market weakens, and investors seek security in commodities traditionally seen as a safe haven during times of economic uncertainty. The Dow-to-Gold ratio has proven to be a reliable predictor of these shifts, as cycles of outperformance by the Dow are often followed by periods of underperformance relative to gold, often during recessions. In such times, commodities – especially precious metals – tend to shine, outperforming stocks and offering investors the chance to protect their wealth.

Dow-to-Gold ratio weakening momentum

Currently, the Dow-to-Gold ratio is showing signs of a slowdown. The once-strong trend line is flattening, indicating a loss of momentum in the stock market. This is an important signal for investors, as history has shown that periods of underperformance for the Dow relative to gold often precede capital rotation events. As this breakdown continues, it raises the likelihood of a recession, which is typically followed by a strong bull market in precious metals.

In the latest Talking Trades episode, we discussed the significance of the negative seven-year rate of change in the Dow-to-Gold ratio, a rare occurrence that has only happened a few times in the last century. Each time this has occurred, commodities, particularly gold and silver, have experienced strong bull markets. This signals that we may be entering a similar phase now, where the momentum behind equities continues to wane, and commodities begin to outperform.

What does it mean for an investor?

For investors, the current environment might present a unique opportunity. As the Dow-to-Gold ratio weakens, and with the negative rate of change in play, we are likely at the beginning stages of a capital rotation. Precious metals are poised to benefit from this shift, as they traditionally outperform during such times. With the potential for a recession on the horizon, shifting focus toward hard assets like gold and silver could be a prudent move to protect and grow wealth.

In conclusion, the insights shared in the Talking Trades episode underscore the significance of the Dow-to-Gold ratio in predicting market trends and capital rotation. As the ratio continues to weaken and the negative rate of change persists, the likelihood of a market shift increases. For investors, this presents an opportunity to diversify into precious metals, positioning themselves for the potential upside in the commodities market.

The opinions expressed in Talking Trades by Patrick Karim & Kevin Wadsworth from NSBC do not purport to reflect the official policy or position of Kinesis. The Talking Trades series is for informational purposes only and is not intended to be a solicitation, offering or recommendation of any security, commodity, derivative, investment management service or advisory service. 

This publication does not intend to provide investment advice, tax or legal advice on either a general or specific basis. Viewers are encouraged to seek independent financial advice before making any investment decisions.