This article about how to use the dow to gold ratio to valuate all the companies in the Dow Jones Index is a great resource for investors in individual gold mining stocks. However, when you are investing in gold mining stocks through an ETF like GDX, GDXJ, RING, GLDX, PHYS, GLD and IAU I recommend you to read this article too.
One of the methods investors can use to help to determine the future price of gold is the Dow to gold ratio. The Dow to gold ratio looks at how many ounces of gold it takes to purchase all the companies in the Dow Jones index, assuming every point in the index represents one dollar.
If you are interested in my thoughts as to where I believe the Dow to gold ratio will go to, I recommend you to read the note at the bottom of the page.
As you can see in the Dow to gold ratio chart above¹ there are periods in recent history where investors have lost confidence in paper assets. These periods come shortly after the performance of the Dow Jones index has peaked and are referred to as a financial crisis. Looking at the chart, it seems that at the end of every financial crisis the Dow to Gold ratio comes down to between 2.9 and 1.4 to 1.
How to Calculate Today's Dow to Gold Ratio Yourself
In the widget which is included on this page on UndervaluedEquity.com you will find real time market data for the Dow Jones index and the gold price.
You can calculate today's Dow to gold ratio yourself by dividing the value of Dow Jones index by the value of the gold price, and with the outcome there are two possible conclusions:
- The price of the Dow is too high.
- The price of gold is too low.
Note: In today’s world governments and central banks do anything in their power in order to prevent the total collapse of the economy. Therefore I must conclude that we are in the midst of a financial crisis! This means that the price of the Dow is too high or that the price of Gold is too low. As with all things in life: the truth lies somewhere in the middle. I believe that the Dow Jones index will come down and that the price of gold will go up. Eventually, I believe the Dow to Gold ratio will come down to between 3:1 and 1:1.
¹ Source: http://simplycharts.files.wordpress.com/2007/03/dowgoldratio2006.jpg