As the Federal Reserve inches closer to implementing another round of monetary smoke and mirrors, gold has once again taken over the Dow Jones Industrial Average for the year. Gold is up 8%, the Dow added 7%, while the 15-51 Indicator has gained a stunning 40% so far this year. It is, in fact, performing as if an economic boom is underway. Here’s the picture.
Even though strength normally outperforms average – it doesn’t usually outpace it by this much. In fact, 2012 has been the largest runaway the 15-51i has ever imposed on the DJIA. The reason for this, I can only surmise, is the consistent flight to quality (a.k.a. strong stocks) since the 2008 crash. In other words, investors have continued to concentrate on stock market strength because of persistently poor economic conditions; and by so doing, the increased demand has driven the 15-51 Indicator to extremely inflated levels.
Stock market valuations should be consistent with Market fundamentals. When they stray too far in either direction, up or down, a correction must ensue – to correct valuations. That’s what a correction is, that’s what it does – it corrects prices.
Let’s take a look at this from a different angle. The chart below is from the March 2009 bottom through today (August 31, 2012). It shows that “the market” essentially reached fair value in November 2010; that can be considered correction from the over sold condition stemming from the ’08 crash. But notice the Indicator’s sizable jump in value since January 2012. You’d think a boom was going on.
By posting such a burst in 2012, when market conditions can be considered nothing short of miserable, the 15-51 Indicator clearly shows what the Dow Average cannot – how inflated stock prices are at these levels.
And where there’s a boom — there’s a bust.
While it is true that another round of QE will add to stock market inflation, there is still no fundamental reason for stocks (strength included) to be valued this high (see: Dog Days of Summer.) It is for this basic reason that stocks sell off when the Dow approaches the action zone high (13,425); and because the monetary situation continues to be so glum, gold stands to benefit.