The gold/DOW ratio is an interesting measure of market volatility as it pairs the price of gold bullion and the Dow Jones Industrial Average (DJIA) over the course of 200 years. The movement in the ratio can allow speculative on economic expansion and monetary policy confidence.
The gold/DOW ratio can signify whether either asset is over- or underpriced. The lower the ratio, gold would be considered overvalued to the DJIA, or equities in general. However, the higher the ratio is indicative of overvalued stocks compared to the price of gold. This measurement of volatility and speculation is no more evident since the creation of the Federal Reserve in 1913. This suggests that the Federal Reserve’s monetary policy is directly relevant to boom and bust cycles, or bubbles. Since the 1940s, there has been 12 boom and bust cycles directly tied to monetary policy, or one boom and bust every six years. (Note: prior the existence of the Federal Reserve, the ratio’s volatility was not as violent and remained within a 75 percent confidence band. Since the Federal Reserve, the ratio escaped the confidence band and resulted in exaggerated moves in the opposite direction).
The gold/DOW ratio without singling out the Fed existence:
Given the current gold/DOW ratio of 12.39, in February 2014, the ratio could continue to move upwards to the band’s midpoint, which would roughly be a ratio of 20.