I'm working on a new indicator.
You see, in our eyes, you can't trust the economic indicators the government puts out: unemployment, CPI, GDP... they're all manipulated, adjusted and revised.
I'd rather deal with real numbers, pure and simple. Things like the price of gold, oil and markets.
You might argue that speculators can come in and skew these prices. And you're right. But these skews are also important. They point to bubbles and oversold situations that can be very profitable.
If you play them right.
The indicator I'm playing around with is a comparison of the Dow to the gold-to-oil ratio. I'm calling it the DOG indicator, since it takes the Dow, oil and gold into account.
Historically, the gold/oil ratio is about 15.6, meaning one ounce of gold can buy 15.6 barrels of oil. From a trading perspective, if the ratio climbs above 21, this means gold is overvalued and oil is undervalued.
The reverse is true if the ratio falls below 12.
Here's the chart from BullionBarron.com, but there are several other places you can find this:
Now here's a chart of the past 40 years for the Dow.
What my indicator is trying to do is match up those points of overbought and oversold ratio territories with major fluctuations in the market.
I'm not quite ready to show you the data yet, but there are some interesting points after 1986 that seem to show investor sentiment.
In the buildup to the 1987 crash, the gold/oil ratio was soaring... jumping from its historical average to 25, then to 30.
We know that oil prices were falling... from $22 a barrel in early 1986 to $11.50 by the end of July that year. That accounts for the huge spike above 30 in the ratio.
But then oil prices started climbing again, and the ratio stayed high... well above 20 through 1987.
That is a key sign of a bubble.
Markets were trending higher, which supported oil prices. By August 1987, oil prices were back above $21, nearly a 100% climb in a year.
But gold buyers could feel a change in the wind... the price of the shiny metal climbed and climbed. By the October crash in 1987, gold prices had climbed to $460, more than $100 above January 1986's price.
This move – if caught by investors – could have helped protect portfolios from the crash and could have even made investors money.
During the first decade of the 21st century, the gold/oil ratio was sinking... Oil prices were starting to take off from severely low prices in the late 1990s. Gold prices were also dropping. These were the Clinton heydays, when the economy was doing very well, and folks were turning to riskier investments.
Gold took a back seat while the Dow rocketed from about 3,300 in 1993 to 10,729 just before Bush was elected president.
Is it any wonder that the gold/oil ratio fell below 10?
A robust economy was supporting higher oil prices and investors were not interested in gold. The bubble was at full speed.
And the longer the ratio was below 12, the choppier the market got.
This instability was a huge cue for gold buyers to step back into the market. At the end of 2008, as the financial crisis hit, the markets were still higher than they had ever been prior to 1998, but those 10 years' worth of gains were wiped out in six months...
And the gold/oil ratio went from below 7 to above 24 in that same time frame.
All this data is going to take a little while to crunch, and to find out exactly what it all means, but the DOG indicator could be the next bubble predictor.
With both oil and gold seesawing, the ratio has come back down into more of a normal range, but the ratio is trending higher.
Combine that with a market that's back above 12,000 and you could have the makings of a big aftershock in our future.
Protect all your bullish bets with hedges right now. With gold flip-flopping with the dollar/euro tango, it might be best to go with some put options on the major indexes for the time being.
I'll keep you updated on what the DOG indicator is doing, and be on the lookout for more of these real indicators that take all the lies and misinformation from the government out of the equation.
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