You are probably well aware that the last few years have been tumultuous, to say the least, for the financial markets. Though the stock market tanked hard through the end of 2008 and into 2009, it has since recovered much of what it lost. Gold has performed nicely over the last few years, though not without some volatility of its own. If you invested in stocks from the end of the tech boom to the peak of 2007 (and hopefully got out then), you probably saw some nice gains in your accounts. In terms of dollars, you are better off, right? You’ve got more of them than you did before, right? But in terms of purchasing power, the true measure of wealth, how did you really do?
The Dow/gold ratio is notable because it gives some insight into the performance of stock market investments from the standpoint of true purchasing power. Though gold has fluctuated significantly in price over the last few years (and decades) it has largely preserved its purchasing power. A century ago, a man could purchase a nice dress shirt for around $1.50 to $2.00 – about 7.5% to 10% of an ounce of gold, which was $20 at the time. Today, a man can buy a nice dress shirt for about $50 to $80, or about 4% to 7% of an ounce of gold, which is around $1220 today. Gold increased in price from $20 to $1220 over that time not because it became more valuable, but because the dollar became less valuable due to monetary inflation by the Federal Reserve. As the dollar falls in value, it takes more of them to purchase the same amount of gold. As the supply of dollars has increased over time, the supply of gold has remained largely stable, hence it takes a lot more dollars to buy the same amount of gold. This stability of gold in terms of purchasing power is a great reason why it is a good gauge of the true purchasing power of an investment over a long period of time.
The DJIA/Gold ratio shows that investments in the Dow have lost purchasing power over the last ten years or so (click for a larger view).
So, how has the stock market been doing in terms of gold? Not good – at least not since the end of the tech boom. In dollar terms, the Dow did very well until 2007, but in terms of gold, investors actually lost purchasing power over that time.
-CH
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