Dow Gold Ratio

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Eric Original
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Dow Gold Ratio

http://stockcharts.com/h-sc/ui?s=$indu:$gold

So where do we go from here folks?  Eventually to 1?

I made it clear on the old blog that I'm currently doing a trade on the ratio dropping.  I own UGL and DXD.

Not designed to be a quick trade or huge money maker, just a long term thing that I think can weather a lot of storms.

What do you guys think?

Edited by admin on 11/08/2014 - 06:31

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uptofreedom
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I think that qualifies as a

I think that qualifies as a safe investment.  Buy-n-hold equal amounts should be a winner over the long run.  Hold/add to the UGL while trading DXD could make sense, I'm doing that with my bastardized DGR play, AGQ/TZA...  But if I were looking for a set it and forget it investment, I'd go with UGL/DXD...

Eric Original
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It's kicking ass today

It's kicking ass today though!

Recent action seems a clear breakout below 8.0.  But like I said, this is a long term thing.

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xaritas
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There's ETF for that

Not saying I recommend it, but for people interested in this trade, there is FSG.

(I don't and probably never will own this).

Eric Original
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Excellent info Xaritas!

Xaritas

You anticipated my next question.

Are UGL and DXD the proper vehicles?  Will they track accurately?  For that matter, will FSG?

There are concerns about whether leveraged ETF's will track accurately over time.  I'd hate to have the right idea, but get screwed with bad execution.  

Are there better ways to play it?

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Sockeye
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can you explain how you set

can you explain how you set this up.

I own UGL and DXD.

How did you get the ratio from these and what are they?

What is going on.  I don't understand what you are doing at all.

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Sockeye
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What are you talking about. 

What are you talking about.  All you have is a list of pronouns.

*It's* kicking ass

*this* is a long term *thing*.

What is *It's*

What is *This*

What is *thing*

What is going on here. Please someone tell us.

Thank You in advance

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xaritas
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Tracking...

FSG is fairly new and not very liquid. It might get popular soon, though. It seems to do pretty well in its short time. My experience with UGL is pretty positive, it seems to do what it is supposed to do and is extremely liquid.

One thing I wondered about is the difference between owning an inverse ETF vs. outright shorting. I know you don't want to use margin, and I avoid it too, but I think an outright short sell of your bear index has the advantage that if both decline, but your bear side declines faster, you still make money. With ownership of the ETF, if they both decline, you lose, and you lose. That's one reason why FSG might be appealing.

I've just started actively trading and this topic is close to the top of my todo list. One nice thing about using Ameritrade, which I know you use, is that you can use the Think or Swim platform to back test your idea. If you log in with the "on demand" feature you can paper trade, and jump around in time. It has tick for tick data going back several months. So you can put each of these trades on and see if they perform as designed.

For those intrigued by this, long gold, short silver is another idea worth considering.

Eric Original
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OK, obviously need some basics

OK, back to basics.

The Dow Gold Ratio is simply the Dow Jones Industrial Average divided by the price of Gold.  It's been charted over long periods and tends to oscillate between the low single digits on the low side  and much higher numbers ( 20,30,40) on the high side.  Basically it's a barometer as to whether the world is moving toward a preference for hard assets (Low Dow, High Gold, Low Ratio), or toward paper assets (High Dow, Low Gold, High Ratio).

There is a school of thought that the DGR (Dow Gold Ratio) is in the middle of a down trend.  Currently just under 8.0, and heading for maybe 1.0.  The way to play that bet would be to be long Gold and short the Dow.  UGL is a 2X leveraged ETF for Gold.  DXD is a 2X leveraged ETF that is short the Dow.  So that's one way to play it.

Note that this is different that simply being bullish on gold.  Suppose a deflationary wave hits.  Maybe gold and stocks both go down.  As long as gold has relative strength versus stocks (in this case, goes down less) then the DGR would continue to drop and the UGL+DXD trade would still be a winner.

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Eric Original
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Did a quick check on FSG.

Did a quick check on FSG.  Over the last month, it appears that it gives about double leverage to what you would get with doing half UGL and half DXD.  That could be good or bad, depending on your point of view.  But certainly worth more investigation.

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xaritas
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How this trade works

Sockeye,

The basic theory is that if you are bullish on one asset, and you think another asset will go down (or even go up, but not up as fast), then you can create a neutral position by buying the thing you are bullish on, but selling short (http://en.wikipedia.org/wiki/Sell_short) the thing you are bearish on.

So "this trade" is long (buy) gold, and short (sell) DOW (or S&P).  A trade like this takes time to develop, but it has less risk because you start out with a net position of $0, because you are putting the same amount of money (note: NOT THE SAME NUMBER SHARES) onto each side. In this case, if gold goes up 1% and the DOW goes down 1%, your gain is 2%. If gold goes up 2%, and the DOW goes up 1%, you still make money (the difference in gain between gold and the DOW). If gold goes down 1%, but the DOW goes down 2%, you make money. And if you're me, you lose money no matter what. (ha)

I'm not sure if this works as well by purchasing a short index, though. I'm relatively new at this, so please do your own research or talk to a real financial advisor. Just giving you a brain dump of some things I've picked up on.

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Various DGR scenarios

Set up a little 2 by 2 grid.  Dow Up and Dow Down across the top.  Gold Up and Gold Down on the left side. There are 4 scenarios.

1)Dow Down:Gold Up.  This is the grand slam home run for this trade.   I'm not sure I give it a huge chance of happening just like that, but I'll take it.

2)Dow Up:Gold Down.  This would be the nightmare scenario for this trade.  But in this fiat money world of ours I give this almost no chance of happening.

3)Dow Down:Gold Down.  I think of this as the Deflationary Scenario.  It could happen.  As long as Gold has relative strength, that is, drop less than stocks, then the trade wins.

4)Dow Up:Gold Up.  I think of this as the Inflationary Scenario. I put the highest probability here.  As long as Gold has relative strength, that is, rises more than stocks, then the trade wins.

Bottom line is I believe the odds are good that Gold outperforms Stocks, through a variety of possible outcomes.  If it does, then the Dow Gold Ratio continues to fall.

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uptofreedom
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Very nice breakdown,

Very nice breakdown, Eric...   Minimal chance it's a loser, medium chance it's a moderate winner and a very good chance to be a big winner. 

If I had to make one investment that I couldn't touch for a year, this'd be it.

Eric Original
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uptofreedom Yeah, that's

uptofreedom

Yeah, that's basically the kind of thing I have in mind.  This is not my wild and wooly trading capital that I'm putting into this trade.  I'm using some of my more conservative $$.

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Robert LeRoy Parker
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Dow:Gold vs Nikkei:Gold

Here is a chart from Gold versus Paper blogspot a few weeks back. The black line is the dow:gold ratio. Look pretty similar.

We may see the same follow through in the dow:gold.

Eric Original
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Excellent chart Robert.  I've

Excellent chart Robert.  I've been looking for a nice long term one like that.  Thanks.

Tip o' the Hat to you!

Just to clarify for folks, the Dow Gold Ratio scale is along the left side, Nikkei:Gold along the right.

And also, just to get it up to date, the DGR is breaking down under 8 as we speak.

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zman
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Ben's report card

I love to follow the Dow/Gold ratio, too me it shows how good of a good job Ben is doing. The ratio hit 7 in March of 9, and then had a nice rally for several years, but now we can see that the ratio is heading lower once again, now at 7.8. Once the ratio breaks the key 7 level, I think we will see 5 in short order. Maybe we see Dow 10,000 and gold 2000, works for me.

Eric Original
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Dow 10,000 and gold 2,000

zman,

those numbers sound quite possible to me too, but the beauty of the trade is it can prosper under a variety of scenarios.  Even a deflationary bust that gives us Dow 5,000 and Gold 1,000 would be the same result and nice profits indeed.

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Eric Original
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Here's a Weekly

Here's a Weekly that covers the period back through the Crash of '08.  

http://stockcharts.com/freecharts/gallery.html?$INDU:$GOLD

Oops, daily up top, scroll down for weekly

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uptofreedom
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more info...

good write-up and charts:  http://caps.fool.com/blogs/the-dow-gold-ratio/327553

great write-up from Jan '07: http://www.lewrockwell.com/north/north501.html

Quote:

In August 1929, your grandfather sold one unit of the Dow and bought 18 ounces of gold. Three years later, when the Dow/gold ratio bottomed at 2:1, he sold 18 ounces and bought 9 units of the Dow.

Those 9 units reached another peak in 1966 when the ratio hit 28:1. Now your father exchanged those 9 Dow units for 252 ounces of gold.

In January 1980, the ratio got to an almost unprecedented 1:1 ratio, so he converted those 252 ounces of gold into 252 units of the Dow.

Come 1999 with the ratio at an unprecedented 43.85 to 1 level, the prudent family converted those 252 units of the Dow into 11,050 ounces of gold!

No trades were based on the price of gold or the level of the Dow . . . it's just a simple question of how many ounces is the Dow trading for in the market.

This little fictional fable started with 1 unit of the Dow at a peak in 1929. Two tops, two bottoms, and 5 trades later it's 11,050 ounces of gold, in 70 years.

good short-term hedge, even better long-term investment...

xaritas
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Back testing

Using Ameritrade/thinkorswim's platform which lets you trade based on historical data, I went back in time and made four trades on Jan 3, 2011 at 9:45 (EST). I bought $10,000 worth of GLD and sold short $10,000 worth of SPY. I also bought $10,000 of UGL and $10,000 of DXD. So my positions looked like this:

3 January 2011
06:45:45  VIRTUAL BOT +72 GLD @138.68
06:45:45  VIRTUAL SOLD -77 SPY @126.94
06:45:45  VIRTUAL BOT +141 UGL @70.67
06:45:45  VIRTUAL BOT +491 DXD @20.37
 
I then jumped to the most recent full day of data, 12 June, right before closing (15:45 EST).
 
Value on 15:45:45, 12 June 2011:
GLD 149.19, position: +755.28
SPY 127.725, position: -61.60
UGL, 80.34, position: +1360.65
DXD, 18.58, position: -$878.89
 
So the positions came to:
 
long GLD/short SPY: +$693.68
long UGL/long DXD: +$481.76
 
One thing Eric's grid doesn't address is DXD's natural decay.

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