2009-03-02

Remember 1989

GOLD (GC) S&P500 (ES)

Still making up my mind about what to do!

Do you still remember 1989 - I was in school around this time in 1989, in class XII. Studying hard (?) for the CBSE exams and various engineering and medical entrance exams which all aspiring students in India ritually take. It was long time before I first got aware of the financial markets and not so long time before I got a taste of my first beer. Life was simple and carefree. There was no mortgage to pay (not even for my parents) and TV's have just stared to appear in my home town. Michael Jackson was still coming out with great numbers  around then. So what is common with 1989 and 2009. Well 1 ounce of gold buys same amount of S&P (a measure of US stocks) as it did in 1989. We certainly have not made much progress financially as the crow flies (without considering dividend of couse which make a significant proportion of the returns from stock market). In the attached chart left scale shows GOLD and S&P500 levels in USD and right hand scale plots the ratio of S&P to GOLD (i.e. how much S&P you could buy for 1 ounce of GOLD). The chart is in log scale to emphasise the relative change. At the time of writing, the ratio is hitting close to where it was in 1989 (0.78 region). 

Now it can mean the following three conclusions:

a) Stocks are very cheap relative to GOLD (i.e. at the level they were nearly 20 years ago) and time to buy stocks.
b) Stock have dropped like stone and there is no faith left in these psuedo measure of wealth and time to pile into "real" assests like GOLD.
c) At least one of S&P or GOLD is overvalued relative to the other and therefore an inflexion point can be in offing.

If you subscribe to option a) time to buy S&P futures and selling equivalent GOLD futures.
If you believe in option b) time to do the opposite i.e. sell S&P futures and buy equivalent GOLD futures (or even physical GOLD if you have lost faith the in whole fianncial world).
If you believe in option c) a market neutral trade can be put on by buying (or selling) equal amount of S&P and GOLD futures. Question would be which direction the ratio is heading.  If the ratio is turning and heading up, S&P would rise faster (or fall slower) than GOLD.  However if ratio is still heading down to regions before 1989, S&P will rise slower (or fall faster) than GOLD.

Certainly times are interesting and that is an understatement. I am tempted for Long S&P and Long Gold position to start with, turning into Short GOLD (if GOLD appears to be topping) or Short S&P (if S&P appears to be tanking further). Let us see what that brings.

For information, 1 S&P emini future is equivalent to 0.3773 GOLD futures so roughly 5 S&P for 2 GOLD.