About a month ago, we reviewed the situation of stocks versus gold by analyzing the Dow/Gold ratio.
Gold rising further from current levels is possible, but history clearly shows the yellow metal suffers summer doldrums, which in the current stage of the secular bull market usually means sideward price action for the coming months.
A sharp decline for stocks seems more obvious, as investors await more stimulus from the Fed, but probably won’t get their new dose of QE immediately, which could lead to a sharp correction.
Furthermore, stock valuations are ballooned, pimped by unusual high profits and extreme margins!
With the steep rise of input costs, due to explosive commodity prices over the recent months, investors could get very disappointed if their high expectations aren’t met.
These are just a few risks which could trigger a stock market selloff…
Today, we are in the midst of an accelerating stock market decline, with the most important indices dropping below their technical support lines. The S&P 500 sank below its crucial 1300-level, while the Dow Jones is nearing in on 12,000 points.
On the other side, gold is going strong, still trading around $1,550/ounce!
This mix – collapsing stocks and strength in gold – translates into a Dow/Gold ratio falling through the floor as we speak. The floor being 7.9x in the Dow/Gold chart.
Our analysis was looking for a Death Cross formation, which would trigger the next leg down for the ratio. Meanwhile, we have entered the crash-territory and are now on our way towards the 7x-level for the Dow/Gold.
We still expect that the ratio will drop even further this time, towards 6x or even lower.
The forcefulness of gold is quite astonishing, trading near its all-time high during these shaky market circumstances. To us, this is a sign of further strength for the yellow metal in the near future, which indicates even higher gold prices than we had anticipated.
The second half of 2011 could spark fireworks within the precious metals arena. We could see the Dow Jones sink further towards 10,000 or below, with a Dow/Gold ratio plummeting, we wouldn’t be surprised to see the price of gold zoom towards $1,800/ounce, even touching the 2,000-dollar-level before the year ends!
We reiterate our advice to avoid or minimize exposure to the general stock markets for the rest of 2011, and use the summer doldrums in gold, and especially (junior) gold mining companies, to load up the truck. With the current strength of gold, we expect it’s going to be a hot fall… again!