How cheap is stock price using the real money, not fiat currency?

 

What is real money? Is the 10 dollar note in your hand really worth 10 USD?

 

The 10 dollar note you hold in your hand simply is a social contract, backed by the US government, that you can use the note in exchange for good or service worth of 10 dollar.

 

However, with unlimited quantitative easing (QE) in the face of COVID-19 and specter of the subsequent economic recession, there is a fear that 10 dollar note may not be actually worth 10 dollar.

 

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That’s why many investors have fled to gold, a standard of real money whose value everyone strongly believes would not depreciate amidst inundation of fiat currencies.

 

Since the stock market bottom in March, both stock prices and gold price have soared. How attractive is the Dow Jones Index historically compared to the value of real money, gold,

 

The chart below shows the movement of the Dow Jones Index and gold price since 1975.

Dow Jones Index and Gold Price

Source: Capital IQ, Investing.com

 

The chart shows that while the gold price has risen less than 10 times, the Dow Jones Index has risen roughly 35 times as of 2020. While the price of real money has increased, stock market has increased by far larger amount.

 

This time, the chart below shows the ratio of Dow Jones Index to gold price. The ratio shows how many ounces of gold it would take to buy the Dow Jones Index at any given time. The ratio of 10 means that you need 10 ounces of gold to buy one Dow Jones Index.

 

Dow Jones Index and Gold Price ratio

Source: Capital IQ, Investing.com

 

From 1975 to 2020, the minimum ratio is 1.3 during 1980 while the maximum ratio is 42.3 around the Dotcom Bubble period in 1999.

 

During the Dotcom Bubble period at the beginning of the 2000s, investors would have been able to buy 1 Dow Jones Index with 42.3 ounce of gold. This is because Dow Jones Index was at 10,800 while an ounce of gold was at 256 USD, compared to gold at 1,700 USD and Dow Jones Index at 25,000 in 2020 May. Clearly, stock market was overvalued at that time.

 

Currently, the ratio stands at 14.2, which is slightly over the average of 13. Historically speaking, the stock market is slightly overvalued against the benchmark of the gold price.

 

Is it a good time to buy stock or gold?

 

These charts may provide a little bit of benchmark to think about.

 

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