Bartering for the Dow

The Dow Jones Industrial Average crossed the psychological threshold of 10,000 last week, before retreating slightly. Once again the Dow is in dollar terms at the level reached back in March 1999. On October 15, John Authers at the Financial Times, pointed out that priced in Euros or gold, the Dow has performed much more poorly. Moreover, it has drastically underperformed emerging markets, and other stock indices.

How has the Dow performed compared to oil? This chart compares the performance of the Dow in dollar terms to its performance when priced in barrels of oil from January 1999 to October 2009.

The price of the Dow in oil is measured by dividing the daily closing level by the daily spot price of oil (WTI). The first day of trading in January 1999, the Dow closed at 9,184 and spot price of oil was just over $12. October 16, 2009, the Dow closed at 9,995, or less than 10% higher than January 1999. In contrast, that same day oil closed at just over $78, 6.5 times the January 1999 price. Measured in oil, the Dow is down 81% since 1999.

Although we don’t literally call our stockbrokers in order to barter oil for stocks, it is important to consider the price movements of equities relative to other assets. In general, the value of equities has declined significantly relative to raw materials, oil being the most salient example. The weak dollar has been closely linked to the U.S. stock market rally, mainly since both reflect increased risk appetite (a weak dollar improves earnings for global companies as well). Yet a weak dollar also has been fueling a further surge in dollar priced commodities. A lot of oil producing countries are very concerned about the value of their dollar reserves. Furthermore, supply concerns will continue to make the world subject to oil price shocks. Whatever impacts animal spirits have on the near term stock market movements, there is little reason to believe that the value of U.S. based equities will perform well when compared to oil, or any other raw material.

Of course the Dow is a bit primitive as an index, especially when you consider that in it, companies are weighted by stock price, rather than market capitalization. Moreover, this analysis doesn’t include the reinvestment of dividends. Nonetheless, in price terms, it is clear that equities have underperformed oil. For a deep discussion of flaws in and alternatives to the Dow click here.

Aussie Aussie Aussie(Oi Oi Oi)

Hat tip to the Australian Central Bank for being the first in the G-20 to make a clear post crisis move away from currency debasement*. Indeed when Central Bank Governor Glenn Stevens boosted the Australian target overnight cash rate by 25 basis points to 3.25%, no one should have been particularly surprised. Yet the markets appeared to react strongly anyways. The Aussie dollar is up against the majors, and gold is way up.

The Australian economy is in a far better situation than the rest of the G-20. Inflation is a bigger problem than contraction. Compared to America, Australia didn't even really have a housing crisis. Australia has benefited from a strong trading relationship with China(Rio Tinto problems notwithstanding), booming exports to Asia and the world of coal, iron ore, alumina, meat and wool. Domestic water scarcity and environmental problems remain a major downside risk, but with population so sparse, this problem seems minor compared to the rest of the world.

The currency trends over the last couple months hints at the strength of the Australian economy, as well as the fact that the rate move was widely anticipated. This chart, highlighting the pound/aussie exchange rate, is ironic when you consider the fact that Australia started as a British penal colony:




We're all gold bugs now

Not quite. Gold reached$1,045 Tuesday, but anyone who got in too late and overleveraged will likely feel a bit of pain as profit taking drives a pull back during the Asian Wednesday morning. That being said, going short gold at anytime leaves one incredibly vulnerable to a low probability high impact tragedy that leads to widespread panic. Take the spike in gold post 9/11 for example. Moreover, even if China scales back on buying raw materials, the Federal Reserve's loose policies will in the long term ceteris paribus make expensive anything tangible that is priced in dollars, even without a global conspiracy to "ditch the dollar."



*Israel raised rates in August, but it is not a member of the G-20