http://home.earthlink.net/~intelligentbear/dj-au-ratio-lt.gif
I’m no economist, but I’d say it’s the commodities “pendulum,” something like this:
Fed raises interest rates, stocks rise immediately, gold rises more gradually. Fed lowers interest rates, stocks fall immediately, gold falls more gradually. Hence the waviness on a generation-by-generation scale.
As to why the ratio is rising…I’m guessing DOW replacement of underperforming companies and the natural upward bias caused by that, as well as [someone else’s answer here].
I would like Neoclassical to comment on the series prior to 1922, and 1922-1929. What do you guys think?
There is a great Legg-Mason paper on the commodity-equity cycle that demonstrates their movement over the past 150 years or so. To sum it up, there are periods which average about 18 years in length where commodities outperform equities and vice versa. I like the Jim Rogers explanation because it’s practical and makes sense. Essentially at one point people all start buying stocks because they’re very underpriced and a long term bull market in stocks begins. As this happens, everybody hops on the stock bandwagon and the prices cotninue to rise. All the while, people neglect commodities which are performing poorly relative to stocks (think most recently commodities from 1983-1999). Eventually, as most things do, stocks end up way overpriced and in bubble territory. The world needs commodities, always has and always will, and thus people begin to notice how undervalued they are. Investment in commodities must pick up, and indeed it does as people begin to pour money into them. The problem is that if the market determines for instance that we need more lead or silver or anything, they can’t just snap their fingers and make this appear. It takes on average 10 years to open up a mine. Now resources have to be put into raising start up capital, finding deposits through exploration, opening the mine, hiring workers and getting equipment, excavating the product(s), and getting them to the market. All this time there isn’t a new supply being brought onto the market and thus there is tremendous upward pressure on prices. Now after some time, on average 18 years, there is a large abundance of commodities which everybody has been buying into and they probably end up in a bubble as well. Stocks are underpriced, and people begin to…well, you get the picture.
The amplitude is always increasing. Be nice to have recessions shaded. The ratio could change w changes in DOW or Gold or both.
Investor Howard Katz writes on this topic frequently (he’s also a minarchist):