Why The Dow Jones Industrial Average Will Eventually See 31,000+

updownLarry Edelson: Ever since the March 2009 crash low, I’ve maintained my view that the Dow Industrials and broad U.S. equity markets were entering a new bull market — and that the Dow Jones Industrial Average (INDEXDJX:.DJI) would eventually hit 31,000+.

One of the major tools I used to come to that conclusion back then was the ratio of the Dow Industrials to the price of gold.

I wrote extensively about it in my July 2008 issue — even before the crash of 2009, which I also forecast — and several times since. Today I want to update that analysis for you.

First some background. At the peak of the ratio of the Dow Industrials to gold in the year 2000, the Dow Industrials would have purchased just over 51 ounces of gold.

During the financial crisis of 2007-09, as equities plunged and gold had rallied (since its bottom in 2000) the ratio collapsed all the way down to the 6 to 7 level.

In other words, in terms of gold — what I like to call “honest money” — the Dow Industrials had lost more than 87% of the entire equity bull market from 1980 to 1999.

Click image for larger view

In my report issue of July 2008, I called for the bottom in the ratio to come in around the 5 to 6 level.

It bottomed slightly above that level, then retested it with a slightly lower low in September 2011.

Since then, stocks have vastly outperformed gold. Here’s the chart I published back then, but with updated comments and analysis.

As a result, the ratio of the Dow Industrials to gold started widening back out, and also broke out of a resistance level, which you can also see on the chart.

Now trading at about the 14.5 to 1 level, the Dow/gold ratio is set to widen much further.

So what does this all mean? And what does it hold for the future for the Dow? For gold?

I’ll answer those questions now. But I urge you to put your thinking cap on, because the analysis of the Dow/gold ratio is not easy to grasp, yet it’s critically important to understanding the future.

FIRST, the collapse in the Dow-to-gold ratio during the financial crisis was not caused simply by a crash in equity prices. It was also due to a crash in the value of the dollar during that time period, as reflected in the soaring value of gold from the year 2000 on.

SECOND, the breakout in the ratio means that the Dow is now beginning to adjust its value to its ratio to “honest money” — as measured by its value versus gold.

This adjusting of equities is perfectly normal and one of the main reasons I am very bullish equities over the next several years (after a normal but sharp pullback occurs).

A simple exercise here will show you why. For the Dow/gold ratio to climb back to the 18 to 20 level resistance level you see on my chart, the Dow would have to explode higher to the 23,480 level, assuming gold’s current price of roughly $1,174.

Naturally, the price of gold is not going to remain at $1,174. So let’s run a simple matrix of the price of gold and assume the Dow eventually gets back to a ratio of 20 to 1.

Let’s say, for instance, that gold eventually falls to $900. At 20 to 1, that would put the Dow around 18,000.

Or take a super-extreme, super bearish price for gold at say, $800. A 20:1 ratio puts the Dow at 16,000.

Clearly, there’s not a lot of downside to the Dow even if gold were to plunge all the way back to $800 (which is highly unlikely).

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