Gold vs. S&P 500

Is it better to buy gold or the S&P 500?  The answer is both.  It’s the timing between the two that’s crucial.  To understand why, it’s best to take a practical look at the two asset classes.  Gold is commonly referred to as a “store of value”.  It is what it is.  Gold has a high value due to its anti-corrosive properties, its density, malleability, luster, and ductility.  However, it does not work or generate any cash flow or grow itself additionally.  This is where stocks come in.  Stocks are a product of ownership of production.  A company brings in revenues, pays fixed and variable costs, taxes, and corporate debt.  The remaining amount of earnings, positive or negative passes to the shareholder in a mix of dividends and reinvestment into the company.  The present value (discounted at the required/market rate of return) of the sum of these earnings establish the stock price of the company, which fluctuates on a daily basis.

The chart below is a graph of the ratio of the S&P 500/Gold Price with respect to time.  This chart does not take dividends into account.

Gold vs SP500

Using this chart it is easy to see which asset outperformed the other over any period of time. Over a given time period if the end ratio is higher than the start ratio, the S&P 500 outperformed gold. If the end ratio is lower than the start ratio, gold outperformed the S&P 500.

For example, take a starting point of 1970 and an point of 2000.  The ratios are 2 and 5, respectively. Over this 30 year period stocks outperformed gold.  The ratio for 1930 is 1.5 and the ratio for 1950 is 0.4.  In this period gold outperformed the S&P 500.
There are a lot of factors that will determine price movements and based on trading activities, politics, and the economy.

Any chart theory is not definitive, and should be used only as part of a complete investment approach.  This method is based on a best value trading of the Gold / S&P 500 pair.  Stocks represent the productivity, but a commodity can become increasingly scarce.  A possible approach would be to trade based on the historic ratio bounds.  In this case rebalancing would occur based on the ratio.  At 0.2, an investor would hold 5 parts stock to 1 part gold (0.2/1:1).  At 5, an investor would hold 5 parts gold to 1 part stock.

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Present value of cash flows

The stock market has taken losses the last couple of days in the face of political uncertainty. It’s important to keep in mind that market moves within any given day are based on rapid changes in market sentiment. The measure of how any asset performs over time is it’s ability to generate and increase cash flow. In the case of a stock, the current price is each future cash flow discounted to the present at the required rate of return. This rate is determined by the market as a whole. The reason for discounting to the present value is that a dollar in the present is worth more than one in the future, at the very least due to the fact that money today can be put to work to earn a return on capital.

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