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A Price Target for Gold if the Dow Has Reached Its Top

By: Simit Patel | Thursday, May 3, 2012

Personally, I think equities are going to head much higher. There are two main reasons for this:

1. With 7.6 trillion USD in bond payments on government bonds due this year, I believe we will increasingly see capital run out of bonds. See the chart below; price suggests the possibility that the top is in on TLT -- the ETF for the 20 year US Treasury bond -- and that it will have trouble breaking beyond 125. So I think capital will increasingly run out of bonds and will need to go somewhere else. That's where the stock market, as well as gold, come in.

TLT Chart
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2. The Fed continues to expand the US money supply; we're now sitting at over 10.8 trillion, using MZM as a measurement. The more MZM grows, the more money needs to go somewhere and the more prices are likely to rise for that reason. If the bond market is unable to generate momentum as we discussed, I think this additional influx of capital will increasingly flow to equities -- doubly so for reliable, dividend-issuing equities.

While I'm confident in that view and position myself accordingly, I do concede that a strong case can be made for the opposing view -- that equities are topping. Certainly the market has been weaker of late, and has had trouble breaking past its all-time highs. The chart below of the Dow Jones Industrial Average illustrates.

DJ-30 Chart
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Fundamentally, the economy will be stagnant and reliant upon further stimulus from the Fed unless debt levels are dramatically reduced, largely through outright debt cancellation. The more debt is cancelled and the less the Fed forces expansion of the money supply is, the more likely we are at the top of equities and will stay roughly in this range for years. If the top in the Dow is 13,500, the highly cited 2:1 Dow/gold ratio puts gold at $6,750. If we look at the gold bull market of the 70s and observe that it marked at twenty-four-fold price appreciation -- from $35 to $850 -- a 24X move from $250 in 2001 gives us a price target of $6,000.

I think these numbers are useful as conservative targets. Formulas advanced by James Turk and Jim Sinclair as to what the price of gold needs to be to re-monetize gold both put the price in excess of five figures. Even if we have the much more modest target of a Dow/gold ratio of 2:1 with no new top in the Dow or a repeat of the move in the bull market of the '70s, we're still more than 3X away from the current price. This is basically why I think gold is still a tough investment to beat, and as conservative estimates are still more than 2X away, accumulation is well-warranted.

 

Author: Simit Patel

Simit Patel
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