The One Tool You Need to Spot the Best Time to Buy Gold

10 minuti di lettura
14 dic 2021

There is one favored tool used by investors to find the best time to buy and sell gold and stocks at any given point in time: the Dow to gold ratio.

If you are a beginner gold investor, you might think that only a magic crystal ball can help you predict the price of gold and pick the perfect time to buy.

Well, this is almost true. There’s no strategy that will give you a definite answer, but there’s a tool that could help you make a well-informed decision. It’s called the Dow to gold ratio.

The ratio has been used by investors for many years now, and has potentially helped many of them avoid some of the biggest stock market crashes in history, notably by pushing them, at the right time, toward safe-haven assets like physical gold.

Let’s see how the Dow to gold ratio works and how it can help us understand when to buy gold.

What is the Dow to gold ratio?

In short, it's a tool that tracks the Dow Jones as priced in gold.

Just to remind you, the Dow Jones (or Dow Jones Industrial Average) is an index that tracks the stock price of the 30 largest U.S. companies, including Apple, McDonald's, IBM, Coca-Cola, etc...

The stocks of the Dow Jones are chosen from all the major sectors of the U.S. economy, with the exception of the transportation and utility sectors.

Ans what the Dow to gold ratio indicates is how many ounces of gold you need to buy the Dow Jones at its current price (aka the amount you see when you type “Dow Jones” in Google).

So if the Dow to gold ratio is at 10, this means you need 10 ounces of gold to buy the Dow.

In other words:

  • When the ratio is high, stocks are expensive and gold is undervalued.
  • When the ratio is low, stocks are undervalued and gold is expensive.

The bottom line is, the more the ratio increases, the more it tells us to sell stocks and buy gold.

And the more it decreases, the more it tells us to sell gold and buy stocks.

It’s as simple as that.

Many well-known investors like to keep an eye on this ratio to determine the good moment to buy and sell, and some like Bill Bonner, founder of Agora Financial, and precious metals analyst Olav Dirkmaat, use the Dow to gold ratio as an integral part of their investment strategies.

How do I use the Dow to gold ratio?

As mentioned above, investors in both gold and Dow assets use the ratio to see whether now is a good time to buy (or sell), and to determine the direction of either market relative to each other.

This is a ratio that’s been used by investors for over 100 years, mainly as a useful guiding strategy for investment rather than a strict rule.

But, to give you a simple example of how the ratio could be used in practice, let’s take a look at what Bill Bonner does with it, a widely quoted investor when it comes to the ratio.

Basically, he focuses on two numbers, 5 and 15, as his reference points. Roughly speaking, here's what he decided:

  • When the ratio goes above 15, I will sell stocks and buy gold.
  • When the ratio goes below 5, I will sell gold and buy stocks.

Here’s a cheat sheet 🤓 :

  • If the ratio goes above 15: it takes 15 ounces of gold to buy the Dow. Gold is considered undervalued (cheap) compared to the Dow Jones Index.
  • If the ratio falls below 5: this means that it takes just 5 ounces of gold to buy the Dow. Stocks are undervalued relative to gold.

Now that you have an understanding of how the ratio could be used, you can decide on your own reference points to follow.

To give you some more pointers, let’s also take a quick look at how it has worked through history.

How has the Dow to gold ratio worked in history?

In general, the Dow to gold ratio has experienced decades-long and powerful trends only diverted when faced by drastic macroeconomic changes.

The historical Dow jones to gold ratio chart below perfectly encapsulates these trends:

The Dow to gold ratio comparing the price of gold and stocks between 1920 and 2020
Dow-to-Gold Ratio from December 1921 to December 2021.

As we can see, after a peak in 2000, the Dow to gold ratio followed a constant downtrend until 2012, where it experienced a rebound that’s still occurring today.

So how would your buying strategy look like if you had applied Bill Bonner’s advice since the 1920’s?

Well, over the past 100 years, you would have made at least six trades.

Here is exactly when Bill Bonner’s strategy would have indicated you to buy and sell gold:

the Dow to gold ratio showing gold and stocks trade cycles based on Bill Bonner’s model
Dow-to-Gold Ratio from 1900 to 2020.

According to the strategy, the red dots mark the periods when you should buy gold and sell stocks, while the green dots are when you should sell gold and buy stocks.

For instance, we see that, from July 1996 to December 2020, the Dow/gold ratio went above 15, meaning that gold was undervalued compared to stocks. This potentially offered a good entry point for those who wanted to buy. At the time, the price of gold stood at $382 an ounce.

And if you had bought gold and sold stocks at that specific time, history shows that you would have had two major benefits:

  1. Avoiding the blast from the 2000 dot-com crisis and the stock market crash of 2008.
  2. Getting into gold just before its bull run that lasted from 1999 to 2011. In this period, the gold price went up from $363 to around $1,825 per ounce, going up 425% in 145 months.

What was the other time the Dow/gold ratio reached above 15?

Well, you might have heard of 1929, the year of the infamous Wall Street crash, which to this day remains the worst stock market crisis in the U.S. history.

Buying 1 ounce of gold then would have cost you $20.63 while selling your stocks was likely to keep you out of trouble.

Usually, stock market crashes occur quickly, and many of the market's biggest crises have had long-lasting effects on investors and their wealth, particularly for those who weren’t prepared.

Therefore, you can see how using the right investment tools, in this case the Dow to gold ratio, can help you prepare for market movements, avoid some potential financial losses, and generally guide your decision on when to buy gold.

Where is the Dow to gold ratio today?

Let’s get straight to the point: the ratio’s going up.

This means, according to those using the ratio, that there might be a reason to be bullish on gold.

Here’s the chart:

the Dow to gold ratio which shows that gold is currently undervalued compared to stocks signaling a good time to buy gold
Dow-to-Gold Ratio in November 2021.

As you can see, in November 2021, the Dow to gold ratio went above 15, reaching as high as 19.42.

That’s close to the levels experienced in 1929, and puts gold in highly undervalued territory according to Bill Bonner’s take on the Dow to gold ratio.

So, are you planning to follow the ratio and ditch some of your stocks to get yourself some physical gold?